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To retire, you'll need $1.25 million

Lynn Brenner | Family Finance

June 15, 2008

I'm a 45-year-old woman, employed at my job for 21 years. I can retire at 56, which I want to do. I can't collect Social Security until age 62. I have nearly $100,000 in my Thrift Savings Plan account, but can't start withdrawing from it until age 59 1/2. My job also offers a pension, based on the years I worked. But I'm not sure about the details because we aren't allow to contact HR about retirement until we're five years away from it. How much should I be saving?

- BB via-email

You may want to reconsider. You've set yourself an extraordinarily difficult goal. Before we get to rules-of-thumb to calculate how much you'd need to carry out your plan, let's explain some of its drawbacks.

The cost of living in retirement depends on variables that range from where and how long you'll live (and how healthy you are) to future inflation and tax rates. But for anybody, retiring at 56 is a very expensive proposition.

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First, you're ineligible for Medicare until 65. Buying your own health coverage is extremely costly even if you qualify for a group plan.

Second, your income will be smaller: When you tap Social Security at age 62, your monthly benefit is permanently reduced. For a person born in 1963, full retirement age for Social Security is 67. If you opt to take a monthly Social Security benefit at 62, it will always be 30 percent smaller than if you'd waited another five years. Your Thrift Savings Plan account will be smaller, too, because you won't contribute to it as long, and it will have fewer years to grow before you start taking withdrawals. Your pension benefit from your job, based on years you've worked, will also be reduced.

Third, the earlier you retire, the longer your nest egg must support you. A 56-year-old has a 28.7 year life expectancy, according to the IRS unisex actuarial table; women on average live longer. In 30 years, the cost of living will more than double if inflation averages 3 percent a year.

Even if you retire at 65, it's not easy to make your savings last as long as you do. The average 65-year-old today lives past 83; and 40 percent of 65-year-old women live to 90, according the National Center for Health Statistics. To be sure her money lasts 30 years, experts say a 65-year-old retiree should limit her yearly nest egg withdrawals to about 4 percent of her original account balance, plus inflation.

That means if you retire with $1 million, you should limit your withdrawals to $40,000 a year plus inflation. The first year, you'd take $40,000. If the inflation rate is 3 percent that year, the following year you'd withdraw $41,200 ($40,000 plus 3 percent). The following year, you'd withdraw $42,436 ($41,200 plus 3percent). And so on. "That way, you're buying a constant $40,000 worth of goods and services," said Christine Fahlund, senior financial planner at T. Rowe Price in Baltimore. This formula assumes that your nest egg is invested 60 percent in stock funds and 40 percent in bond funds, adds Fahlund.

So how much do you need to save for a 30-year retirement? Take the percentage of your current salary you want your nest egg to replace, and divide that number by four, Fahlund said. Let's say you want your annual withdrawal to replace 50 percent of your current salary (plus 3 percent a year for inflation). Divide 50 percent by four. The answer: 12.5. At retirement, you need a nest egg that's 12.5 times your current salary. So if you now earn $100,000, and want a nest egg that can produce a constant $50,000 a year for 30 years, better plan to retire with $1.25 million ($100,000 times 12.5).

Send questions to Family Finance, Business Desk, Newsday, 235 Pinelawn Rd., Melville, NY 11747-4250, or e-mail to Bfamfin@aol.com. Include your age, income and a list of major assets. Letters and e-mails can't be answered personally.