Don’t look know, but the Fourth of July is right around the corner. And in what’s become a time-honored tradition, we use the celebration of our nation’s independence to discuss how you can become (and remain) financially-independent.
Here’s how much you need, how to get there, and how to stay there.
The Magic Number
The key to figuring out how much money you need to be financially-independent is not your income, assets, or investments.
It’s your spending. More specifically, what you spend each month, both now and in the future. First, figure out what your typical “outgo” is for transportation, food, gas, utilities, entertainment, groceries, insurance, etc. If you’re a renter, include that figure, too.
Then subtract what you expect to receive each month in Social Security and any pension payments. Then multiply the net monthly cost by the number of months you plan to live.
For instance, let’s say you spend about $4,000 per month now, but expect to receive $1,500 per month in Social Security payments in retirement, and plan to live for 25 more years (about 300 months).
Your net monthly expenses in retirement will be $2,500 ($4,000 minus $1,500), and you would multiply that figure by the 300 months you expect to live. $2,500 multiplied by 300 months equals $750,000—that’s the amount you would need to retire comfortably.
But don’t stop there—you should also add in any debt you have, such as credit cards, car loans, or your mortgage. If you’re open to selling your home at some point down the road, you can subtract the estimated net equity you have in the home from the amount you need to accumulate.
Staying independent in retirement
You can use a permutation of this formula to figure out how much you can spend each month in retirement. Add up your net liquid investments (i.e., retirement accounts, savings, CDs, etc.), then divide the amount by the amount of months you expect to live.
The resulting figure is how much you can spend each month, above and beyond Social Security and pensions. For instance, let’s say you have $500,000, and you plan to live thirty more years (360 months). Divide $500,000 by 360, and you get $1,388. That’s what you can spend next month (again, above and beyond your Social Security and pension payments).
How are you doing?
Of course, if you’re far away from retirement, you probably would like to see if you’re on track to be able to retire with enough money to support yourself. Use this decade-based formula to see where you’re at.
If you’re in your twenties, you should have about ten times your net monthly expenses saved. In your thirties, you should have 25 times your monthly expenses, and in your forties, 50 times your monthly expenses.
By the time you reach your fifties, you should hopefully have at least 100 times your net monthly expenses, and in your sixties, you will hopefully have at least 200 times your monthly outgo set aside in savings.
The best way to get there
If you do the math, and the result causes you some anxiety, don’t worry—you still (hopefully) have some time left to save more money towards retirement.
And that’s the best way to accelerate your progress: saving money in to a pre-tax retirement plan, like an IRA, 401k, or 403b.
First, saving more money into a plan like this leaves less money for you to spend each month. By lowering your spending, you lower the factor that determines how much you need to save, and at the same time increasing how much you have saved.
You also get a great “instant” return on your investment. That might be a matching contribution from your employer, but it will definitely be from a reduction in your taxable income.
Depending on your situation, you could save ten to forty cents in this year’s taxes for every dollar you save for retirement.
Which seems appropriate, since much of the initial struggle for our nation’s independence was caused by outrage over taxes.