The most common question asked by those who invest for retirement is, “How much money do I need to retire?” That cannot be answered until you answer the question, “How much money do you need to spend each year?”
The answer to that question – and the answer is entirely up to you – is the critical ingredient when it comes to knowing how much is needed to retire. No one can tell you what sort of lifestyle you want to lead. That is inevitably your personal decision. Some people are happy with a paid for house and $2,000 a month to spend. Others insist that $100,000 a year is what they really want. You must decide what's right for you.
Once you have done that, a ballpark estimate for how big your portfolio needs to be isn't too hard. First, if the estimate you have made is after tax spending, you need to bump it up a little to get back to pre-tax figures. Adding 25% is roughly right; you can refine your estimate by using the tax estimators in the previous message.
Now deduct what pensions you will receive in retirement, because your portfolio won't have to produce that income.
The historical evidence is that you can take roughly 4% from the starting value of an investment portfolio, raising it each year by the inflation rate, without running into disaster. If your portfolio will need to support you for a period longer than 30 years, e.g. because you are an early retiree, then shave a little from the 4%, say 3.3% instead. History is not a perfect guide to the future, but barring nuclear war, natural disasters, or complete economic collapse, 3.3-4% should be your guide. That gives a convenient way of estimating the total funds required as 25-30 times what the portfolio needs to produce each year.
A simple example: The 63 year old Mr. Magoo wants $40,000 per year after taxes to spend in retirement. Before tax, it's about $50,000. CPP will pay $6,000, OAS $5,000, and his company pension $11,000 per year. His portfolio needs to generate $28,000 per year in retirement. At a 4% withdrawal rate, his portfolio should be worth at least $700,000.
Consider annuities if any of the following are a concern
- You and/or your spouse are relatively healthy and are likely to live longer than average.
- Maximizing your income in retirement is more important than leaving an estate.
- You want a guaranteed monthly income stream regardless of how long you live.
The first two-thirds of How to Completely Avoid Outliving Your Money
provides a good introduction to annuities.
Since their purchase is irreversible, always seek professional advice before you purchase an annuity.