How To Prepare For A Successful Retirement, Part 1: Planning For Your Income & Expense Needs
How much money do I need to save up to retire comfortably? This is a commonly asked question, one that I get fairly often. My response is that it depends on your monthly living expenses in retirement. This answer typically triggers a follow-up question: How do I plan for these future expenses when I don’t know how much they will be? Let’s walk through how to prepare for a successful retirement, focusing on income and expenses needs.
When approaching retirement, there are many factors to consider, such as when to file for Social Security, pay off outstanding debt, choose your exact retirement age, etc. When you start thinking about these different variables, determining the most optimal course of action can be overwhelming and confusing. While there is much to consider, I will simplify the process so you better understand how to plan for your financial circumstances.
First, think about how much you want to spend every month in retirement. This can be hard to answer because your income, needs, and wants differ greatly. Look at your current monthly living expenses as of today and think about how these expenses may change.
Using a very simple example, let’s assume your current monthly living expenses are $5,000. This figure includes all outstanding debt payments, utilities, groceries, insurance, etc. Let’s say your mortgage payment is $1,500 and will be paid off by the time you retire. If all else stays the same, it is fair to assume that your monthly retirement income needs are $3,500 ($5,000 – $1,500).
While you want to at least maintain your current standard of living, start thinking about what you are looking forward to in retirement. Do you plan on traveling more frequently? Are you interested in donating your time and/or money to a specific charity? Would you like to help your grandkids pay for college? You should start thinking about these things now, along with the associated costs.
Continuing with the above example, let’s say you want to travel worldwide for retirement. To make things simple, we won’t focus on travel location or frequency. But let’s assume you want the flexibility to spend $2,000 every month purely on travel expenses in retirement. This means the range of what you will be spending every month in retirement is anywhere between $3,500 and $5,500 ($3,500 + $2,000). Now that we have your estimated monthly living expenses, we can figure out exactly how much money you need in your portfolio to retire.
As a general rule of thumb, you should withdraw no more than 5% of your total portfolio value every year in retirement. For example, if you retire with $1 million, then you can withdraw $50,000 annually in retirement and not dig into any principle. We assume you will have an average annual portfolio return of 7%, and we subtract 2% to reach 5% in inflation. We never want you to take more than what you make in retirement.
Back to our original example, if monthly retirement expenses are $5,500, that is $66,000 per year. So, you need to retire with roughly $1.3 million to meet these expenses. Since you will be spending within a range, it’s likely you won’t need to withdraw this amount every single month in retirement. However, it’s efficient to plan like you are spending this amount so you have no financial limitations and can fully enjoy the life you worked so hard for.
Once you have estimated the dollar figure you need to retire, you have to decide where exactly to save your money to reach your goals. Most individuals have retirement plans through their employer. I recommend starting with your retirement account through work because your employer will typically match up to a percentage of your salary. Please take advantage of this match because it’s essentially free money going into your retirement account.
If you don’t have an employer plan through work, I recommend a Traditional IRA or a Roth IRA. Traditional IRAs grow tax deferred and are advantageous for older individuals in high tax brackets. Whereas Roth IRAs grow tax-free and are advantageous for younger individuals who have plenty of time for their income to grow and are in a lower tax bracket. The annual IRA contribution limit for 2025 is $7,000. Since January, if you want to max this out, you need to contribute $583 per month to reach $7,000 by December.
All the accounts I have mentioned so far have strictly been retirement accounts. This means you have to be age 59 ½ to withdraw funds, or else there is a 10% early distribution penalty. There are exceptions to this rule, but retirement accounts generally have stricter rules than individual accounts. Individual accounts do not have contribution limits or an early withdrawal penalty based on age. Individual accounts are great as a supplement to retirement accounts because of their flexibility and tax advantages.
As far as how much you should be contributing, that answer is dependent on when you want to retire and the dollar amount you need to retire. I recommend utilizing an online financial calculator to estimate how the account can grow based on your current savings rates. If the calculation produces an amount lower than what you need, you should bump up your contribution rate. As a general rule of thumb, I recommend increasing your contribution by 1% annually or every time you get a raise; that way, you don’t notice the subtle increase over time. I would start by contributing the minimum amount to your employer plan to at least get the full match and increase 1% annually from there. Of course, it is the same idea as IRAs or individual accounts.
This article helps clarify and simplify the process of planning for retirement. There are so many variables to consider, but the first step is figuring out what you want your retirement to look like and translating that into dollar terms. Next time, we will discuss how to minimize taxes in retirement and go into more detail on how to structure withdrawals. If you have questions or need assistance with retirement planning, I recommend working with your financial advisor.