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Finding the Magic Number: How Much Do You Really Need for Retirement?

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If you make a huge amount of money, you don't need a retirement plan, right? Once you become rich, you can buy what you want without worrying about the future. Just get your hands on a big pile of cash and you're set for life. The money will take care of itself.

Unfortunately, many Americans hold that viewpoint, even though they wouldn't put it that bluntly. In my own practice as a financial planner, I've seen clients get into financial trouble in spite of making high salaries. Some are doctors, lawyers, or engineers -- educated professionals who earn six-figure incomes. Strangely enough, though, education doesn't necessarily lead to sound financial decisions.

Here's a case in point: I once had a doctor as client. He was 42 years old and had run his own private practice for a decade, earning a six-figure income. Nevertheless, he accumulated $500,000 in debt -- not even counting his home mortgage! The debt consisted of credit card bills, an auto loan, and unpaid student loans from medical school. Amid all this financial turmoil, he hadn't saved anything for retirement.

How did such a high-earning professional mismanage his finances so completely? On a superficial level, the reason is simple: The doctor spent more money than he took in. Yet if we look more deeply, we can see some psychological factors at work. My doctor client became accustomed to living a doctor's lifestyle, a lifestyle involving luxury cars, country club memberships, and European vacations. He fell into the trap of "keeping up with the Joneses," and in this case, the Joneses were eminent physicians. Here's the moral: A high salary won't automatically protect you from financial problems.

The doctor eventually realized that his finances were imploding and that he faced two choices: either scale back his spending, or drastically reduce his standard of living in retirement. Fortunately, he was young enough to correct course. Not everybody has that advantage.

In October 2013, a Wells Fargo survey of 1,000 working adults found that 34 percent plan to keep working until age 80 because they don't have enough money to retire comfortably. The same survey found that another 37 percent plan to keep working until they get sick or drop dead. Clearly, a lot of Americans haven't put much thought into retirement planning.

This problem is solvable. You can get a handle on your debts and develop a feasible retirement strategy. Sure, retirement planning is complicated -- you have to sift through mounds of information about IRAs, 401(k)s, and the myriad of retirement plans available in the U.S. But the main idea of retirement planning is pretty basic. I call it the "magic number."

The magic number is simply the amount of money that you need to get from the 1st to the 30th of the month. Ask yourself: What number do you need in your bank account every month to get by? By "get by," I mean several things: meet basic living expenses, save for emergencies, and maintain a little bit of money for entertainment. Whether you make $30,000 or $300,000 a year, the principle is the same.

When you cut through all the jargon, retirement planning involves two steps: First, finding your magic number. Second, devising a strategy to replace that number every year for the rest of your life. Once you take those two steps, the rest of your strategy falls into place. Finding your magic number makes other things possible:

1. Knowing the magic number guards against "lifestyle inflation." As we've seen, that disease afflicted our doctor friend. Like many people, he told himself, "My wages are rising, so my lifestyle should, too." In medical school, he ate Top Ramen noodles and survived; as a doctor he dined on steak and premium wines. If your desires rise as fast as your income, you won't attain financial security.

2. It gives you a roadmap towards a sustainable retirement income. In my own financial planning practice, I've seen clients obsess over the right percentage of their paychecks to contribute to their retirement accounts -- five percent, ten percent, or what? Knowing your magic number, you have a specific amount to save for, and distractions fall out of sight.

3. The magic number redefines retirement. Instead of asking, "How many more years should I work," you'll ask, "how much money do I need to reach my magic number?" Retirement then becomes a question of ability, not age.

Retirement planning is difficult for many Americans because they simply don't know where to begin. But once you define a problem, solutions become possible. It's the same with retirement; many of us are lost in a sea of uncertainty, far from land. The magic number will act as your lighthouse, guiding you to financial security.

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