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Your future happiness depends upon a specific number that many people say is unknowable.

Imagine if you knew exactly how much money you’ll need to support yourself in retirement. You would be empowered to save what you needed — and no more. You would know when to retire, how much you could spend, where you could live, and so much more. You would have the confidence to pursue your dreams and the comfort in knowing you won’t run out of money. You would unlock one of the greatest mysteries of your future.

Would you want to know how much?

Well, you can, and here’s how to figure it out:

Guiding principles

There are two principles we start with. They apply to almost everyone.

Principle #1: You want a post-retirement lifestyle like your pre-retirement lifestyle.

Principle #2: You can make slight course corrections to your expenses as needed.

Following those two principles, you’ll know how much you need to live on (Principle #1) and you know it doesn’t have to be precise (Principle #2).

To use a golfing metaphor: 
 If you can land it on the green, you’re close enough.

The following steps, stories, and tips will show you how much money you need to retire. The idea is simple: Expenses are covered by two income streams: monthly benefit payments and savings/investments. We can accurately predict the first two — expenses and benefits — and the left-over amount will come from savings/investments.

Easy peasy. Here’s how we’re going to do this:

1. Determine your annual retirement expenses.

2. Add taxes.

3. Figure out how much your benefits will cover.

4. The leftover amount is used to calculate your answer!

Tip: if you’re in a hurry you can scroll down to the shortcut.

1. Annual retirement expenses

Grab a paycheck or a W-2 and multiply it out to determine your annual take-home pay (not your gross income). Then…

1. Subtract the amount you put into savings (you won’t be doing that in retirement).

2. Include credit card purchases but subtract the “extra” amount you’re paying above that to retire old debt (that’s the equivalent of savings).

3. Will your home be paid off? If so, subtract your mortgage payment (but not the taxes).

4. Add the cost of Medicare (age 65+). Part A is usually free and Part B costs about $150 a month for most people. Round that up to $300 to safely cover Part D, deductibles, and copayments. If you’re retiring early, add the cost of healthcare for the years before you turn 65.

5. Add some fun money if you plan to pursue an expensive hobby (like travel, golf, or horse racing).

What number did you end up with? That number is the amount you’ll need to maintain your current lifestyle in retirement (except for income taxes — we’ll get to that later).

Expense patterns as you age

Note that your retirement expenses won’t always be the same. For most people, it increases slightly for a few years after retirement and then slowly declines over time.

While the Future Reduction may look larger than the Initial Rise, it’s not — because future money is uncertain and has less value. We’ll call it even, so unless you expect some craziness in your future, you don’t have to adjust your expense number to accommodate these common variations.

2. Taxes

Retirement life is a great escape from the drudgery of employment, but you can’t escape the taxman. The government always wants your money.

The downside is that much of your income will be taxed. For most of us, 85% of Social Security income is taxable. Pensions are usually funded with pre-tax dollars and are also taxed. Interest income is taxable. 401k and traditional IRA withdrawals are taxable. Savings and Roth IRA distributions are among the rare income sources not taxed.

The good news is that it’s not as bad as you think. Your “effective tax rate” is lower than your “tax bracket”, which is usually the number everyone tosses around. In the charts below, you can see that tax brackets are individual layers. The first layer is taxed at 10%, the second layer at 12%, then 22%, and so on all the way up to 37%.

This means that even though you may be in the 22% tax bracket when you add up the tax amounts from each of the lower layers, your effective tax rate will be less — somewhere between 11.5% and 17.1%.

To calculate your taxes:

1. Start with the Annual Expenses you calculated above — in retirement that’s about the same as your income.

2. Subtract the standard deduction ($24,800 or $12,400).

3. Multiply by your Effective Tax Rate. Round it down a bit since your SS will only be taxed at 85%.

Caution: State taxes matter, so be sure to add them. Seven states have none, but the rest have a patchwork of rules. You can find more information here.

3. Future benefits

Recurring income streams are regular payments you’ll be receiving from Social Security, pensions, or annuities. It’s easy to look up your SS benefit — go to SSA.gov to find yours. If you’re lucky enough to have a pension or annuity, check with your employer or plan administrator to get that amount. In either case, you’ll have to pick a retirement age, but don’t worry, it’s not a formal commitment.

Don’t count physical assets. Boats, planes, cars, and your home have value, but they don’t generate income, which is what you need to pay bills. They can be liquidated in dire emergencies, but don’t count them as an income stream in your retirement calculations. One exception is rental properties: You can count the net income as recurring income.

Here’s what you just did:

1. You determined your retirement expenses.

2. You added taxes.

3. You know how much your benefits will cover.

The left-over amount must be covered by savings/investments.

Savings and Investments

This includes investments such as IRAs, 401k’s, mutual funds, and conventional savings accounts. Unless you have a significant inheritance pending (be careful counting money you don’t have), savings and investments will have to cover the balance of your retirement expenses without running out before you die.

Luckily, you don’t need to save up decades worth of cash, you only need to save enough so the interest will cover most of your left-over expenses. The combination of interest and small slices of your principal will take you safely through your retirement years. If you think you might live beyond 30 years in retirement, you’ll want to add a little more upfront.

Exactly how much you need to retire

Multiply the left-over amount by 25 and you have your number!

The multiplier, 25, is based on the 4% rule which says you can safely take 4% from your savings each year in retirement and be confident it will last for 30 years or more.

You already have savings, so you’re well on your way. Now you can look at how many years you have left to go and make savings a priority.

The shortcut

If I lost you at “grab a paycheck,” you can use the chart below for some guidance. It’s based on the calculations discussed above, and uses typical ratios of income-to-benefits.

Pick a “Current Annual Living Expenses” row. The blue bar estimates how much income will likely be covered by recurring income streams like SS or pensions. The orange bar estimates the leftover amount that needs to be covered from savings and investments.

The corresponding red number is a great target for “how much you’ll need.”

How do you compare?

If you’re on track, congratulations! Now’s a great time to celebrate.

If you’re a bit behind on your goals, take comfort in the fact that you’re in good company. The median retirement savings for people approaching their 60’s is less than $100,000.

So, what do you do if it looks like you’re coming up short? Don’t worry — there are plenty of options:

• Keep working and focus on stashing away as much as you can. Take a look at your current living expenses and slice and dice your way to a higher savings rate.
• Recognize the difference between “Need” and “Want”. I want to live in the style to which I’m accustomed. I need food to eat and shelter to keep the rain off my head. Focus on your needs.
• You may decide to work part-time in retirement. Again, you’re in good company — almost 40 percent of retirees in their 60’s are enjoying a part-time encore career. A post-retirement career provides purpose, engagement, and slows the drain of limited funds.
• Cut costs. Why not downsize now — no need to wait for retirement. Or you may consider living out some of your retirement years where the costs are less. Here’s an article on The Top-10 Countries for Living an Amazing Low-Cost Retirement Life. There are plenty of wonderful places in the US and Canada as well.

Regardless of your situation, you can make your retirement the dream you’ve always wanted. It just takes a little planning and discipline.

Have a wonderful retirement!

A word about early retirement and timing: If you plan to retire early, be sure to add the cost of the extra years you’ll be drawing on savings before your benefits kick in. In addition, if your retirement is a decade or more away, today’s dollars should be adjusted for inflation. Add 3% a year.

NOTE: The author is not a licensed investment professional. This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.