I recently got this question from one of my co-workers, who is in his late forties, and I was surprised and a bit perplexed that he would ask this question.

We often debate our pension returns in my office (among 4-5 close colleagues) and I love that this topic is not taboo in our office.

We rarely discuss absolute numbers though – we usually just compare our rate of return.

One guy was under the impression that he had received close to 0% return on his pension for the past 10 years (managed by a large pension provider in Denmark). I found that really hard to believe (given that the avg market return for the past decade has been above average) – but unless you follow it closely (like I do), you can’t really know for sure. I’m pretty sure his real return is somewhere in the 5-10% range, but he definitely felt that he had received close to nothing for a long period.

Perhaps it’s because you see the amount of money going into your pension on your payslip (12% company paid and 5% by the employee in our company) and then you forget to subtract TAX and the cost of insurances that typically follow our pension schemes in Denmark (death, critical illness and loss of earning capacity are common here). These insurances can run you anywhere from €1200-€2500 per year – I know this, because I’ve moved pension provider every time I’ve moved job (which is 5 times in the past decade), and every provider has a different payment structure, and the price of insurance can vary from provider to provider just as much as the rate of return varies…

Anyway, back to the question!

My colleague asked me:

 How much money do you actually need in your pension account by the time you retire?

I suspect that a lot of people don’t know this, so I was not surprised that he would ask this question. Most people will go to their bank or their pension provider and ask this question, and they will try their best to answer it – based off how much money they can earn off your account in the meantime…

What surprised me was the fact that he had this notion that when he retired he was expecting to live 100% off of his pension portfolio. The followers of this blog would know that I recommend at least 3 different “buckets” or pillars. I have my pension, my equity and my Total Balance (investments) that I’ve dubbed “My 3 pillars of wealth” – but the more the better, of course 😉 (Let me know how many you have?)

Anyway, to answer the question, you’d first have to know how much money you’d be expecting to spend in your retirement, obviously. You could use your current spending as a reference. That would work for most people I reckon. However, if your (expected) retirement date is 20+ years in the future, you’d better account for a little something called: Inflation.

Doing the math

We currently burn through around €50.000/year in our household. To my great despair, recent updates to The Trinity Study suggests that the 4% withdrawal rate might be a bit too optimistic, so the 25x (yearly expenses) rule might no longer apply. However, I’m in my optimistic corner today, so lets stick with the 25x-rule for now! 😛 (if you’re unfamiliar with this rule, see this previous post about the math behind early retirement)

So in our case we’d need €50.000 x 25 = €1.250.000 in order to retire (comfortably). So if I want to retire at my current spending level, I’d need a portfolio (invested) of more than €1 mio. Shit. That’s a lot of money. – And mind you, my current goal is only €400.000 (for my Total Balance only though – so that’s just 1 Pillar).

Well, if we account for inflation, and imagine that my retirement age is 20 years from now, I’d need almost €74.297/year (2% inflation/year) in the year 2041 in order to sustain my current purchasing power. See simulation from an Inflation Calculator below:

But wait!…It gets even worse. What about TAX? If you somehow manage to stash €1.250.000 into your retirement account and plan to withdraw 4%/year, you’d get slapped with about 37% tax on that “income” (in Denmark at least, alas!). So after tax you’d only have €31.500 left. Not quite enough to sustain your lavish lifestyle (remember we’re basing these calculations on our CURRENT spending levels).

So if you actually want those full €74.297 in cash – in your hand (or your bank account) – in the year 2041 you’d need a staggering €2.950.000 in your account (using 4% SWR and 37% tax)…

And THIS is why you shouldn’t rely solely on your (employer provided) pension scheme, if you’re blessed to even have one, to fund your retirement. 

Different income streams are taxed differently, but the BEST “income” (in Denmark at least) is: home equity. If you have equity built up in your house (that you’ve lived in), and you sell it and have a profit – that profit is tax free. Of course, if you’ve sold your house, you need to find a different place to live?! – Or you keep the house, and borrow against the equity instead? The options will depend on your LTV at the time of your retirement of course – but having equity is a great lever, for sure.

But what about a Withdraw-to-zero strategy?

If you think dying with close to €3.000.000 in your (retirement) account is a bit silly, then there is an alternative to the 25x-rule called withdraw-to-zero. The idea is that you allow your portfolio(s) to eventually reach € 0.

Depending on your current age, your retirement age and the amount of potential income streams (pillars) at the time of retirement, the withdraw-to-zero strategy can greatly reduce the required amount that you need to accumulate in order to finance your retirement.

I hope to retire before I turn 50. That’s in 12 years. Lets play around with the numbers using an investment calculator:

I’m 38 years old. I want to retire in 12 years. My current starting balance (Total Balance) is €115.000 and I contribute €1000/month for the next 12 years until I retire. My Annual return is 5% (inflation adjusted). I withdraw around €4.200/month (inflation adjusted – but NOT tax adjusted, because I also expect my WIFE to contribute to our retirement 😛 )

If I retire at the age of 50 years old, with a Total Balance around €500.000, I will run out of money by the time I turn 62.

– BUT, by then my pension pillar will be accessible, and it will be substantial in size, given that the same rate of return has applied to this part of my portfolio (the current value of my pension portfolio is more than €232.000, and in this example I would continue to contribute to this portfolio for the next 12 years – before I retire early, and then I would not contribute to the pension pot for ever again). I should actually be close to €750.000 at this point, but just to be conservative lets just imagine that it’s only €500.000.

We know from the above simulation that this should then last me another 12 years. I’m then 74 and it’ll thus be time to start “withdrawing” from my equity, which at this point should be somewhere in the €750.000-€1.000.000 region.

At the age of 74 years, it might be time to sell the house and move into some sort of elder-friendly accommodation (rental) anyway. So I figure I should be good for the next 12-16 years, which would make me 100 and pretty broke – but hey, I was a “slave” for the first 50 years (give or take) of my life, but a free bird in the remaining 50. What more could a guy ask for? 😉

So, how much do you need?

 It depends on how many pillars you base your (future) finances on.

How many have you got, and when do you expect to retire? 😉