Do You Know Your Retirement Number?
August 10, 2011There is a series of humorous commercials that show men and women holding a long, seven-figure number under their arm. This number is supposed to represent “their” number; the amount they will need to save in order to enjoy the retirement they are looking forward to. It seems silly, but the truth is, very few people actually know how much they will need to save in order to retire comfortably. Even our own research suggests that only about one in three employees has used a retirement calculator. With so few crunching the numbers, it’s any wonder retirement confidence is at record lows, but the good news is that this number doesn’t have to be a mystery. Let’s look at six (relatively) easy steps to finding yours:
Step #1: Estimate how much income you will need each year in today’s dollars.
Think about the things you would like to be doing if you were retired today. Would you travel a lot? How much golf or recreational sports would you enjoy? Would you have a mortgage, own your home, or simply plan to rent? How much would you set aside for medical insurance and taxes?
A good rule of thumb is to plan on replacing 80% of your current income, but you can also use this budgeting worksheet for a more accurate estimate.
Example: With no house payment, occasional travel, a weekly round of golf, and dining out regularly, I imagine I could enjoy retirement at around $50,000 a year.
Your Step #1 Answer: __________
Step #2: Subtract inflation-adjusted fixed retirement income sources
Reduce your future desired income by the amounts you expect to receive from inflation-adjusted sources such as Social Security, rents, working in retirement, etc.
Example: I project my future Social Security benefit to be around $30,000 a year, so my adjusted desired income would be $20,000 a year.
Your Step #2 Answer: __________
Step #3: Convert that number into future dollars.
Use a financial calculator to turn today’s dollars into future ones. Inflation has hovered around 3% historically, but you can be conservative by using a higher rate.
Example: Using 3% as my annual rate of inflation, in 25 years my $20,000 a year income would increase to $41,875.86 a year.
Your Step #3 Answer: __________
Step #4: Subtract non-inflation-adjusted fixed retirement income sources
Reduce your future desired income by the amounts you expect to receive from sources like pensions or annuities that are not inflation-adjusted.
Example: I won’t receive a pension or an annuity so this won’t affect my income needs.
Your Step #4 Answer: __________
Step #5: Assume a reasonable rate of return on investment
Whatever your number happens to be, it will consist of money you have saved for retirement. Since retirees tend to invest more conservatively, it’s best to assume a lower rate of return than what you may expect prior to retirement. Although past performance is not a guarantee of future returns, this estimator can give you an idea of how your assets may have performed based on historical data.
Example: I expect to maintain a balanced investment strategy in retirement. Even so, I’ll still keep my expected rate of return at 4%.
Your Step #5 Answer: __________
Step #6: Determine how long your money will need to last
No one knows for sure how many years they will live to enjoy retirement, but this simple life expectancy calculator, along with family history, can give you a suggestion.
Example: Sadly, I’m only expected to live to be 80, but just to be on the safe side, I’ll use age 90 as my life expectancy. That means if I plan to retire at 65, my money will have to last 25 years.
Your Step #6 Answer: __________
Step #7: Calculate YOUR number
This final step requires the help of a slightly more sophisticated financial calculator. To discover YOUR number, plug in your desired income from Step #4 as your initial payment, your expected return on investment from Step #5 as your rate per period, an inflation rate of 3% (or more) for your growth rate, and the number of years you would like your money to last from Step #6 as your number of periods.
Example: Following these six steps, MY number is $898,608.71
What’s YOURS?