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Retirement: Estimating Your Monthly Income Needs

When it comes to retirement planning, many of us look at things in terms of building wealth in a way that results in a huge nest egg. The reason behind this, of course, is to attempt to create a situation in which you have a large enough nest egg that, once you move it into less risky investments, you can live mainly on the interest it produces, withdrawing only a small amount of principal each year. With a large enough nest egg, you are supposed to be able to make your money last indefinitely, even after the ravages of taxes and inflation take their toll on your real returns.

While saving up to build a nest egg in a tax-advantaged retirement account (such as a 401k or an IRA) is an important part of building for the future, you might not know how much money you will need in your nest egg to make it work. Additionally, you can help your future by cultivating multiple income streams so that you are relying on more than just what comes from your accumulated nest egg.

Estimate Your Monthly Income Needs

The first thing you need to do is figure out what your monthly income needs will be. You can do this using your current income needs as a starting point. Look at your currently monthly expenses. Some of these expenses might disappear by the time you retire. Indeed, if you will have your home paid off by the time you retire, a monthly mortgage payment may no longer be an issue. (You might want to keep it in your calculations, though; you might decide to travel or spend money on some other hobby.) Some suggest that you will need about 70% of your monthly income in retirement. I like to base my estimates on my expected monthly expenses, though. This can give me a general idea of my likely income needs.

Using 100% of your current monthly expenses as a basis for your estimate can also be useful, since it’s better to overestimate your needs, rather than underestimate them. If you plan to adopt an expensive hobby, travel, or if you are worried about rising health care costs, you can consider adding expenses on top of what you already pay now. If you plan to downsize your lifestyle, and sell many of your belongings, you can reduce your estimated retirement expenses in relation to your current expenses.

Now that you have an estimate of your monthly expenses, you can use that to determine your monthly retirement income needs, and figure out a plan to meet them.

Building Your Nest Egg

If you estimate that you need $4,000 a month in income, that’s $48,000 a year. If you assume 4% interest yield on your nest egg, you will need $1.2 million in your nest egg to provide you with enough to live on. You can use various retirement and compound interest calculators to determine how much you need to set aside in order to reach that amount. If you put $1,000 a month in your retirement account for 30 years, and you average 6% a year (compounded annually for simplicity in this example) you will wind up with a little more than $1 million. You will just come up short. You will have to either use some of your principal each year, or scale back your expectations.

Another issue with relying on the size of your nest egg to fund your retirement is that you never know what might happen. Will your retirement portfolio yield an average of at least 6% a year? What if a market crash occurs just before you retire? What if you move your assets into bonds and CDs, and they don’t offer 4% each year? And, of course, what if you didn’t start building your nest egg early enough, and you don’t have 30 years to accumulate the wealth you need.

Developing Revenue Streams to Meet Your Retirement Income Needs

What if, instead of $1.2 million, you will only have $800,000 in your retirement account by the time you retire. If you live of 4% of it, that amounts to $32,000 a year -- $2,667 a month. That leaves you $1,333 short each month. Now is the time to start developing revenue streams that might be able to help you close the gap. Social Security might be able to close the gap (if you think it will be viable when you retire), but with decreasing benefits, and the possibility that you retire before you can take full benefits you can take matters into your own hands.

You can start now to work toward creating an income stream to supply the shortfall. Dividend stocks, web site monetization, staring a business, or earning royalties from a creative work are all ways that you can develop extra income streams. These things, though, don’t just spring into being without effort. It can take years to build income streams. Many people spend a decade or two building income portfolios, carefully investing in dividend stocks, bonds and CDs, and then reinvesting the earnings. It is conceivable that such a strategy could result in an income that could help you close your monthly income gap.

Some even take on side jobs, part-time jobs and do odd jobs to earn extra money for a few years, and use that money to fund an income portfolio, or build up a retirement account. Developing alternative income streams, though, has the added benefit of being able to supplement for a time if your tax-advantaged retirement account has been hit by a market crash. Having an outside income stream can help cushion the blow. Even though your underlying investments may suffer losses, an income portfolio with cash, bonds and dividends will still supply you with a stream of income (although it may eventually be reduced somewhat) while your nest egg recovers.

Bottom Line

Building a nest egg to help support you in the lifestyle you want in retirement is important, but you don’t have to rely only on that. Break your goal down into a monthly income goal, and develop a multi-pronged approach for reaching your desired monthly income.

  |     |   Comment #1
Be sure to include ALL expenses, not just monthly ones. Keep an account for the things that occur regularly to avoid nasty surprises. A paid off mortgage means you still have taxes and insurance. Other things like car maintenance and gifts are often not monthly but plannable. If you are part of a couple, look at what would happen to income in the event of either dying or having a long illness.
  |     |   Comment #2
The reasoning in this article is faulty. When I was planning, I figured $2,000,000. would be plenty- At 5% , that is $100,000. per year.Our  Expenses are about $90,000. a year.

   I actually have about $4,000,000. now, but with interest rates at 2 %, that is only $80,000. per year.Running in the hole, and health insurance just went up $400., per month.

  |     |   Comment #3
@#2:  How are you "running in the hole" if your expenditures outpace interest earnings by $10k per year? If your savings are 4 million, it will take many many years before savings erosion starts to cut into your standard of living. 
  |     |   Comment #4
Well, I see where he looks at it like 'running in the hole'.  He may be 60 years old and could possibly have another 30 years left to live off his nest egg so he doesn't want to touch the principal.  Who knows where inflation will go.  The 90,000 he needs now could be 200,000 needed in a few years, and if you're elderly it could be awfully challenging to come up with more money.  Long term health care could be looming in his future and I'm sure he wants to have enough so he doesn't end up with a roommate in a bathroom scented state run nursing home, how much would that add to his monthly bills, 6,000? 10,000?  I've got friends who think you're rich if you have millions but their monthly pension is more then they'd get from interest on those millions, and they can count on it (or maybe not nowdays), plus several have lifetime health plans.  I think they're the lucky ones.  Being "rich" is not what it's cracked up to be.
  |     |   Comment #5
If he's that worried about his future care, he can use his nest egg to buy the security of long term care insurance and an annuity. He'll be assured of comfortable living throughout his remaining years, but have nothing left in his estate.
  |     |   Comment #6
4 million life is tough eh?
Paul L
  |     |   Comment #7
Interesting comments. WIth millions in the bank you would think you are all set. We have over 3 million, but I am only 47. wife is 54. Without knowing when and if the rates are going up, still have to work, Maybe at 5 million I will retire. Health insurance is the scary one. Look around , you can get 3 percent if you don't mind keeping the cash tied up for awhile
  |     |   Comment #8
Sorry, but 4 million should be enough to reasonably live on, and so should 3 million. Probably, most of us are here to try to find the best returns available, and share what we may find, in order to enhance the income situation for all of us and are working with far less  principal than the amounts mentioned in the previous posts. Although your points are noted, instead of whining about not being able to sustain your obvious lavish habits, please contribute some constructive info, if you have any, on how the rest of us can obtain decent returns on our relatively meager principal. In the meantime, congrats on your good fortune.
  |     |   Comment #9
Anon #8 - this is how you get people who might have helpful posts not to bother. People who are working to plan well look at a 4 % safe withdrawal rate, not the total assets. There is lots of constructive information on this site. Hope you use it well.
  |     |   Comment #10
I'm not quite sure if some people are really complaining about the low return on their principal or bragging about their wealth???
  |     |   Comment #11
to 10 definetly the latter
  |     |   Comment #12
does anybody know a good poor house obviously that where i am heading at 57 and retired only have 650k net assets  maybe the RICH FOLK W 3 AND 4 MILL CAN FLOAT ME A  LOAN BUT REMEMBER RICH PEOPLE IT IS EASIER FOR A CAMEL TO GO THROUGH THE  EYE OF A NEEDLE THEN A RICH MAN TO GET INTO HEAVEN MARK 16 ;20 
  |     |   Comment #13
The example used by the author ignores inflation -- a serious problem in an article like this.  Yes, $1.2 million at 4% will indeed yield the $48,000 a year needed, in the hypothetical.  But of course inflation will likely continue, so that $48,000 will go up during the 20 or 25 years of the retirement.  Yet the 4% yield will not.  So the analysis is flawed.
Paul L
  |     |   Comment #14
Not bragging about the wealth at all. It is amazing, buying a small house and living there forever, having one kid and thats all. Working 60 plus hours a week and finally having something. Choices, and a bit of luck may get you there. And yes complaining about a low return was the reason for MY post. But this blog has always helped my returns, they call me the CD detective at work, Thanks Ken.
  |     |   Comment #15
Think whatever you wish about me.  My husband, a never smoker, died at the end of May at age 59 of late stage lung cancer that had metatasized to his brain.  I'm 56 so pretty interested in making what I have last.  It's been a tough couple of years. Whatever I have has to make it through my lifetime along with earnings.

I'm knowledgeable about investing and have managed the finances for years. I have a fear of misstepping now so I hope anyone working on safe withdrawal rates, what accounts to use in what order and any other insight continues to post.

  |     |   Comment #16
With all due respect to all posters, the best path to a secure retirement is a proper asset allocation. If you have a net worth of $4 million but it's all tied up in illiquid real estate which throws off no cash flow, that's imprudent. On the other hand, if you have a net worth of $4 million and it's all in a savings account yielding 1% (or less), that's imprudent. A 4% safe withdrawal rate is predicated on a prudent mix of stocks, bonds/cash and liquid investments which can easily be tapped in retirement, and which (historically) should yield enough to support a 4% withdrawal (plus adjustments for inflation) over at least 25 to 30 years. On top of that, prudence also dictates that one has an emergency fund (preferably in after-tax money) to cover "stuff" that seems to happen, but which is seldom accounted for in a monthly budget. There are a gazillion threads over on Bogleheads that discuss the concept of safe withdrawal rates in depth. Retirement planning is complicated, but, in its complication, surprisingly elegant in its simplicity. It's not rocket science.

Just my $.02.


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