Retire On Time, Make It Last: Here’s How

It’s the single biggest question facing working Americans of all ages: Can I retire on time, and what will happen once I finally quit working?

Financial planners can sit you down and do a real work-through of every variable in your life — housing, health, kids, your lifestyle, to help you retire on time. But it helps to do the “back of the envelope” calculation as soon as possible. You can’t meet a goal you haven’t set, and this is a big one.

One simple way to think about it is in terms of the classic “4% rule.” While the applicability of the rule is in question thanks to low bond yields, the math is still useful for figuring out how much money you need to retire on time at a targeted income level.

Simplified, you take your portfolio’s total value and multiply by 4%. That’s how much you can expect to live on, leaving aside for the moment Social Security and any pension you might have.

In number terms, that means you need $1 million to generate $40,000 in income. A $3 million portfolio creates an income stream of $120,000 a year.

How does it work? It’s deceptively easy math: 1% of 1 million $10,000. Times four is $40,000. If you assume a market return of 7% minus 3% inflation, you end up with $40,000 for every $1 million you control as a maximum withdrawal rate.

If the market does better, you reinvest. If it does worse, that reinvestment should protect you through the “down” years.

Scary numbers, I know, but it’s crucial to think about your money in terms of the eventual income it will produce if you plan to retire on time.

So crucial that the U.S. Labor Department is considering changing retirement law to require defined contribution plans, more commonly known as 401(k)s, to explain workers’ savings in terms of lifetime income after retirement.

Many state pension systems already do this. If you have a state plan, it likely clearly illustrates on each statement how far your money will go in retirement as a monthly income.

That’s a huge help if you expect to combine your 401(k) savings with Social Security income later. Similarly, if you log on to the Social Security Administration web site these days, they also will project your retirement income through the government retirement system, tailored to you.

By combining these two numbers, it should be relatively easy for people to arrive at a sense of how far off the mark they are as they near retirement.

It’s harder, of course, when you’re younger and need to estimate so many future costs. Nevertheless, back-of-the-envelope math can at least help to set a goal to retire on time.

Now for the final piece of the puzzle. How do you get to that target? Here’s where another rule of thumb can help, one known as the “Rule of 72.”

Financial planners use this often. It has limits, of course, but the basic math answers a lot of questions about how your money grows over time.

The Rule of 72 gives you the number of years required to double your money in an investment. The other number you need to know is your rate of return, the “speed” at which your investment increases in value.

How to retire on time

If you believe your investments will increase at an annualized rate of 7%, for instance, you take 72 and divide by 7. The result is 10.3. It will take a little more than a decade to double your money.

As you can see, a lower rate of return means it will take longer. Getting 3% means waiting 24 years to double. Likewise, earning 12% means your money doubles in just six years.

The really important lesson here is compounding. As you save, your money grows into more money all by itself.

If you put away $100,000 and it doubles in 10 years, that’s great. But over the next 10 years, it doubles again — $200,000 turns into $400,000 and then into $800,000 at the end of just 10 more years.

So, there’s your homework assignment. Whether the Labor Department gets this rule change approved or not, sit down soon and figure out if you’re on track and, if not, what it would take to retire on time.