What is a nest egg anyway?

The concept of a retirement nest egg is simple. Your nest egg is saved money you use to fund your life in retirement. Typically, this nest egg is in the form of an investment portfolio (stocks, bonds, and other invested assets). The nest egg is a mix of your original contributions, plus investment gains. While the nest egg concept is simple, the challenge is determining the value your nest egg needs to be before you can retire. In fact, it can be so challenging, that some personal finance writers have said it’s “pretty much impossible.”

So what’s the point?

You may ask, “If it’s so hard to precisely determine the size your nest egg needs to be, what’s the point of trying?” The answer is that once you have a number you’re aiming for, you can work backwards to determine what you need to save to get there. This will make it easier to prioritize saving now, and ultimately, improve your quality of life in retirement while gaining a lot of peace of mind along the way.

Remember: Perfection is the enemy of the good. You can put a lot of time and energy into following complex formulas for estimating your nest egg needs. But none of that guarantees it will be any more accurate than some much simpler formulas. Therefore, we recommend estimating your number now, work toward it as best you can, and then do the simple exercise again every year or so. This is exactly the approach the MoneySwell Retirement Planner helps you follow. (Users with a MoneySwell account can track their progress over time.) Following this exercise can ensure you’re on track and make adjustments as needed.

Now that we’ve gotten that out of the way, let’s dive into three common methods!

Method #1: 4% Withdrawal Rule

What It Is

The four percent withdrawal rule or “4% rule” for short, is a guide for how much you can withdraw from your retirement portfolio. In turn, it can be used to estimate how big your retirement nest egg might need to be assuming you plan for a roughly 30 year retirement. The idea is that in your first year of retirement, you can withdraw up to 4% of the total value of your retirement portfolio and that is your income for the year. In the years that follow, you can withdraw the same dollar amount plus inflation. So for example:

• Value of Your Retirement Portfolio: $1,000,000

• Year 1 of Retirement: Withdraw up to 4%, in this case, $40,000

• Year 2 of Retirement: Withdraw up to $40,000 again (plus a little more for inflation if needed, maybe $800 which is 2% – a possible inflation rate – of $40k)

Why It Matters

The 4% rule is not a perfect science (see links below). Some have said that it’s too conservative, others that it’s too aggressive. Some say it will allow you to achieve a retirement that lasts indefinitely, others say only 30 years. Regardless of experts’ opinions on the rule, almost all would agree it’s a helpful method for planning purposes. As a planning tool, the 4% rule gives you a rough sense of how much passive income you may be able to generate from an invested portfolio of assets.

How To Apply It

1. 1. Determine Your Income Needs in Retirement: If you’re decades away from retirement, we get it, you don’t know how much you’ll need. If you think you’ll make more money later in your career, take a guess at what you might make right before you retire. Then, assume you’ll need 85-100% of that income level to sustain a comparable lifestyle.
      • Example: John is 40 years old and makes $85,00 now but hopes to be making about $125,000 by the time he retires. His income needs in retirement will be between 85% and 100% of $125k (i.e. between $106,250 and $125,000).
        
   2. Subtract Other Sources of Reliable Passive Income: Any source of income that doesn’t come from your retirement portfolio reduces the income your retirement portfolio needs to generate. For example, if you own a rental property when you retire, any net rental income can be subtracted from income you need to generate from your retirement portfolio. The most common source of passive retirement income is Social Security (a government benefit you become eligible for after working a certain amount and reaching a certain age, typically 67 but sometimes earlier). Whatever the case, for step two, consider any income that is likely to last for the bulk, or all, of your retirement years.
      • Example: John has determined he wants $110k of income in retirement. He estimates he’ll generate $25k of annual income from Social Security, and an additional $15,000 in income from a rental property he owns (he’s already paid off the mortgage on the rental property). He now knows his portfolio needs to generate $110k (income desired)- $25k (Social Security income) – $15k (rental property income) = $70,000 in annual income from his retirement portfolio.
   3. Divide the Final Income Number By 4% (.04): Since your retirement “nest egg” only needs to generate some of your income your total income will be 4% of your retirement portfolio plus your other sources of income.
      • Example: John needs his retirement portfolio to generate $65k in income annually. So he takes $65,000 / .04 = $1,625,000.
   4. Final Number: John needs about $1.6M in his retirement portfolio at the time he retires.

Method #2: Income Multiplier

What It Is

The income multiplier method helps calculate your nest egg needs by focusing solely on your income and multiplying that number by 10 (at the low end) to 17 (at the high end). This is obviously a significant range of multipliers and can vastly change your estimated nest egg need number. But most experts suggest that 10-12 times your final pre-retirement income is a good estimate. A 12x multiplier and up is mostly needed for those looking to retire earlier than a traditional retirement age.

When choosing a multiplier for your situation, consider the following:

• How much you currently spend (high spender relative to your income, higher multiplier)
• When you want retire (retire later, lower multiplier, retire earlier, higher multiplier)
• How long you expect to live (live longer, higher multiplier)
• Whether you expect to reduce, maintain or exceed your pre-retirement lifestyle (reduced spending in retirement means a lower multiplier, higher spending in retirement means a higher multiplier)

Why It Matters

The method is nice in that it’s the simplest math you’ll ever do to generate a retirement nest egg number. That makes it a good starting place. The challenge is with the wide range of multipliers. But by using savings guideposts based on your income and age age (see below) you have another tool that tells you if you’re roughly on track. But remember: the guideposts are rough estimates. Your situation may make them more or less realistic. For example, if you pursued higher education late into your twenties or early thirties, this likely delayed your ability to save in earlier years and you may need to save a little more to catch up.

How To Apply It

This method can be applied in two ways.

• Track Your Progress with Guideposts: In the table below, find the age closest to where you are, multiply your current income by the multiplier. This is roughly how much you should have saved at that age.
  

Age	Income Multiplier
30	1
35	2*
40	3
45	4
50	6
55	7
60	8
67**	10

* We’ve seen the age 35 guidepost as low as 0.9x of your salary, so, again, there can be quite a bit of ambiguity with these guideposts.

**Fidelity uses age 67 because that’s “full retirement age” according to the Social Security Administration.

• Determine a Final Number: Pick an income you expect to have near retirement age, multiply that income number by a multiplier between 10 and 17.
  
  Example: John is 35, currently makes $60,000 but expects to be making $125,000 by the time he retires. $125,000 (final income) x 10 (multiplier) = $1,250,000 nest egg number. Since he currently makes $60k and he is 35, he should have roughly $60,000 x 2 = $120,000 current retirement savings.

Method #3: Annual Spending

What It Is

The Annual Spending method is similar to the Income Multiplier method but with two key differences. Firstly, it’s based on spending instead of income. Secondly, it explicitly takes into account any other passive income you may have outside of your nest egg. (This is also done with the 4% method.) How does it work? Take your current annual spending (consider everything you spend money on including rent/mortgage, insurance, food, entertainment, travel etc. etc.), then subtract any sources of passive income, then multiply that number by 25 to 30. That’s your nest egg number.

Why It Matters

For many, the Annual Spending method provides a feeling of control compared with the other methods. Namely, if you can reduce your spending, you also reduce the amount your nest egg needs to be. Of course, this assumes you can maintain that level of spending (or less) throughout your retirement. If you think you’re going to spend more in retirement, you’ll need to use your planned retirement annual spending number and multiply that by 25 to 30. Like the 4% rule, this method assumes you withdraw 4% (or less) of your initial portfolio value, annually in retirement.

How To Apply It

1. Estimate Your Annual Retirement Spending: Consider that in retirement some costs may go up (e.g. healthcare, travel budget), some may go down (e.g. clothing, commuting), and there may be some costs that disappear entirely (saving for retirement, mortgage, supporting your children). While your situation may vary, financial experts generally think your spending in retirement is likely to lie somewhere between 80% and 110% of your final pre-retirement spending.
2. Subtract Passive Income: Subtract any income that is reliable and passive (or relatively passive) from your spending number in step one.
3. Multiply Your Number from Step #2, by 25 to 30: The smaller your multiplier (e.g. 25), the smaller your nest egg number. The larger your multiplier (e.g. 30) the larger your nest egg number. If you’re planning on a lavish retirement (e.g. lots of travel or expensive hobbies), or, one with high expenses for any number of different reasons (e.g. perhaps you have mortgage or are still supporting your children or you anticipate high healthcare costs) or, you plan on retiring earlier than most (say your late 50s or early 60s) you may want to use a multiplier closer to 30.
   
   Example: Jane and John plan to retire in fifteen years at age 60. They will have paid off their mortgage and are in good health. They also plan to travel extensively. They spend about $115,000 per year and would like to continue spending that much in retirement. Given their good health, and lack of mortgage, but also plans for extensive travel and retiring a few years earlier than most (and before they can collect any Social Security), they are going to use a high multiplier, 30. Finally, they rent a condo that generates about $12,000 a year of additional income. They’re not factoring in any Social Security income since they would like to not claim that until they’re 70.
   
   Jane and John’s Nest Egg Number is: ($115,000 (desired total annual spending) – $12,000 (reliable passive rental income)) x 30 (multiplier) = $3,090,000

Summary

You now know three very common nest egg calculation methodologies and how to apply them. Whether you are on track with your savings or have some catching up to do, set a goal in your sights and start working toward it.