What Do I Need to Retire?

It’s amazing how much my attitude toward pretty much everything has changed in the last five or so years. Five years ago I didn’t want any children at all. I now have two. Five years ago I wanted to be a consultant that traveled forty weeks a year, so I could see all the great cities in the U.S. Today, it’s difficult to pack up for a week of business travel without my wife and kids. Five years ago I spent money on everything I wanted and saved anything that was left over (if there was anything). Today, I save according to goals I set and spend whatever is left over.

That last point is a fundamental difference in mindset between people who end up living comfortably in retirement, and those who struggle with debt their entire life and into retirement (if they CAN retire). Those that spend first and save later feel the need for immediate gratification and think that they will someday get around to saving for retirement. Those that save first and spend later understand that living moderately, but comfortably, now is crucial to living comfortably in their later years.

To make it worse, it isn’t easy switching from a “spend first” type of person into a “save first” type of person. You have to give up many of the things you take for granted like brand new cars, I-Phones, plasma televisions, and other luxury items. You may have to bring your lunch to work four days a week and buy a $300,000 house instead of stretching for a $400,000 house. It certainly wasn’t easy when I made the change, but I started to set goals and cut back where needed in order to reach them.

Since my retirement goals require by far my largest contributions, I’ll share my goal setting process for that portion of my financial plan. Here’s what I did:

First, I decided how much income I wanted annually in retirement (in today’s dollars)

For the purpose of this article, I will assume this number is $50,000. Remember, if you plan well, you won’t need your full income at retirement. Experts estimate that you will need approximately 70-80% of your income for retirement.

Next, I estimated how much of a nest egg I needed to produced that income

A decent, but not perfectly accurate, rule of thumb is to multiply your desired income by 20 to 25. So, for our example, we would need $1 million to $1.25 million when we retire. It may seem like an overshoot to save this much money in order to produce only $50,000 a year, but remember, in retirement your money will likely be generating smaller returns of 4 to 5% because of a safer asset allocation.

Now that I have my desired nest egg, I need to figure out how to get there

These calculations are a bit more involved because of all the tax consequences for various types of investments. To figure this out for your situation, take a look at these retirement calculators at Fool.com. For this example, I will assume I am investing in a 401(k) or other tax-deferred retirement account. Assuming thirty years until retirement, an 8% annual return, and 3% inflation, it appears I would need to save approximately $20,000 to $25,000 per year to reach my goal. Hopefully there is a company match!

Now that I know how much I need to save, I have to cut costs to free that money up

For this, I will refer you to some great posts from around the personal finance blogging world:

Whatever your goals, start earlier rather than later. Take advantage of the wonders of compound interest!