3 Ways to Calculate Your Retirement Number

How much money do you need to retire? This question is being asked by millions of retirement savers. It's a simple question. Unfortunately, it's not so easy to answer.

There are a number of rules of thumb proposed to help us answer this question. You could also jump in and crunch the numbers yourself. Here are three methods for calculating your retirement number, along with some helpful tools for each method.

Income method. This method is the simplest. Simply take your current income and multiply it by a factor to determine how much you need to retire. Exactly how much you should multiply your income by is a matter of debate.

Fidelity recommends that you have eight times your final income. A family making $100,000 a year would need $800,000 to retire, according to this method. Charles Farrell, author of "Your Money Ratios: 8 Simple Tools for Financial Security at Every Stage of Life", recommends saving as much as 12 times your final income, depending on how much of your income you want to replace during retirement. These guidelines assume that an individual will receive Social Security benefits in addition to income from savings.

Underlying these rules of thumb is an important assumption. These calculations estimate that you will require a certain percentage of your ending income in retirement. Most assume you'll need 60 to 80 percent of your pre-retirement income. Using these numbers, you can subtract your expected Social Security and pension benefits to determine how much your nest egg needs to generate each year. With that number in hand, simply multiply by 25 to determine how much you need to save to retire. (Note: This approach uses the 4 percent withdrawal rule.)

There is one drawback to this approach. What you need in retirement is to cover your expenses, not a proportion of pre-retirement income. While most people may spend 60 to 80 percent of their pre-retirement income in retirement, there are certainly some people who will not.

Expense method. The goal of this method is to define your retirement number based on your expenses in retirement. Many people using this method keep a detailed monthly budget. Tracking expenses enables them to have a reasonable understanding of what it will cost to retire.

Adjustments to budgets often must be made. For example, in retirement you're unlikely to continue saving for retirement. You may also have your mortgage paid off or move to a less expensive part of the country. Your pre-retirement budget may need to be adjusted to arrive at a retirement budget.

Once your likely expenses are known, determining your retirement number is a matter of simple math. Step one is to subtract Social Security benefits and other income sources from retirement expenses to determine how much must be met from your savings. With the remainder, and using the 4 percent safe withdrawal rule again, simply multiply by 25.

As with the income method, there is a drawback to the expense method, particularly for those many years away from retirement. With decades left until retirement, it's difficult to estimate what your expenses will be many years from now.

Savings method. This method is in some ways a hybrid of the previous two. The savings method doesn't directly attempt to estimate retirement needs. Instead, this method requires an investor to save a set percentage of their gross income. Under this approach, the minimum savings rate is 10 percent of gross pay, although many (myself included) recommend at least 20 percent. As you save a greater percentage of your income, two things happen.

First, the more you save, the larger and faster your nest egg grows. Second, as you save more, you learn to live on less. The result is an ever-increasing retirement account with lower expense needs in retirement. When taken to the extreme with a savings rate of 50 percent or more, this approach has enabled some people to retire at a young age.

The savings method does raise an additional question. How much income will the savings generate? You can always use the 4 percent rule to get an estimate. A free tool offered by Personal Capital will also calculate what they call the financial sustainability index. FSI will show you, based on all of your investment and savings accounts, how much monthly income your nest egg can safely generate. It accounts for inflation and market fluctuations, and is updated in real time as your investments grow.

Rob Berger is the founder of the personal finance blog the Dough Roller.