Trying to
calculate the amount that you need for retirement—your "number”— can be
overwhelming and scary, especially in your 30s. Don't be afraid, be empowered. No
one knows what company pensions or social security will look like by the time
we retire, but we do know one thing—we cannot depend on anyone else financing
our retirement. The sooner you set goals for retirement the better you will be
able to adjust as life changes, and the more prepared you will be to live out
your ideal retirement.
Not everyone has
the same retirement need. Let's face it, your goal is to maintain your ideal
lifestyle, not just to die before you run out of money. So the first step is to
define your ideal retirement lifestyle. Once you figure out how much you need,
then we can determine what it takes to get you there. According to the 2012
EBRI Retirement Confidence Survey, only 35% of workers age 25-34 and 41% of
workers age 35-44 report having tried to calculate how much they need to save
for retirement. Why bother calculating? The study also states “workers who have done a retirement needs calculation tend to be
considerably more confident about their ability to save the amount needed for
retirement.”
Meet Your Inputs
Before we begin
the calculations, I’d like to introduce you to the variables used in the “time value of money” calculation, and the choices you make in each category:
Present Value-
How much you have today. This is all of your assets earmarked for retirement. Ignore
your home, your emergency fund, your checking account, and the savings you will
soon spend on the vacation/ new home/ wedding of your dreams. This is not your
net worth, rather the amount you have saved strictly for retirement today.
Choices: Which retirement accounts are available to you,
including 401(k)s and IRAs? How much of your current assets are truly set aside
for retirement?
Future Value-
How much you will have in the future. There are two future values to consider:
the amount of your retirement account at retirement, and the amount you would
like left over when you pass away. I know what you are thinking- why do I care
if there is anything left? It is important to consider whether you would like
to leave funds to your kids, your favorite charity, or another loved one.
Choices: Is it important to me to leave a legacy or inheritance?
How much?
Interest-
The rate at which your retirement account will grow, and the rate at which
inflation will grow. No matter what your financial advisor/ family member/
favorite TV pundit leads to you believe, no one knows the future market returns
and inflation numbers. We do not live in a linear world and we will go through
periods of high returns (and inflation) and periods of low or negative returns.
Based on historical data for capital gains and dividends, I use 8% for
accumulation (prior to retirement) and 6% for distribution (in retirement). The
idea is that your investments are more aggressive before you retire and more
conservative in retirement. I actually believe that these are conservative
estimates for those of us in our 30s as the average 20-year stock market
return, including dividends, is closer to 10%. I use a 3.5% inflation rate in
my calculations. I'm sure you have all heard ad naseam the financial industry's disclaimer that "past performance
is no guarantee of future performance." Apply it here.
Choices: How are your retirement accounts invested? Are you
willing to take more risk for a potentially higher return? Can you afford to
keep your savings in cash and low-return investments?
Period-
How long you have to save for retirement, and how long your payouts will have
to sustain you in retirement. In order to calculate both of these numbers, you
must first make a retirement date assumption. Do you want to retire at 50? 60?
70? The normal retirement age for our age cohort, according to the Social
Security Bureau, is 67. If you plan to retire earlier you will have to really
ramp up your savings as you have a shorter period to save and those savings
will have to last you a longer time. Remember also that you are penalized for
retirement account withdrawals prior to age 59.5 (with some exceptions), so you
will need a plan for income and healthcare prior to that age. When considering
life expectancy, assume you will live into your mid- to late- 90s. This is
where I would use the phrase "prepare for the worst and hope for the best,"
except that it infers that the "best" case scenario is dying early!
Choices: Ideally, when would you like to retire? What is your
absolute date? Do you have a plan in case you are forced into early retirement?
Payments-
How much is going IN your savings while you work, and how much comes OUT in
retirement. This is very important, as this is the area in which you have the
most control. In fact, your savings rate is single best indicator of you
reaching your retirement goals. This is also the area where your ideal
lifestyle comes into play, both pre- and post- retirement.
Choices: How much are you willing to forego today to save for
tomorrow? How much will you need to withdraw in retirement? Does your company
offer retirement plan contributions you can count towards your savings goal?
What's My Retirement Income?
There are two
primary methods of retirement income determination—the expense method, in which
you calculate your actual expenses, and the income replacement ratio method, in
which you simply assume a percentage of your current income. Both pose some
problems. I believe it is virtually impossible to predict your expenses 30
years out from retirement. Look at the current retirees paying for internet and
cell phones—who would have thought! And the issue I have with the income
replacement method at this stage in our lives is that many workers in their 30s
are still building their careers and growing their income. So while I prefer
the income replacement ration, you will likely need to make some adjustments.
Planners typically
use 70-80% of income as the replacement ratio. I have yet to see a retiree
actually reduce their standard of living upon entering retirement. Who wants a
lower standard of living once you actually have time to do what you want? And most
retirees still have a hefty tax bill since the majority of retirement savings
is tax-deferred. I prefer to determine retirement income using total current income
minus retirement savings (won’t need that anymore!) and other expenses that
legitimately end, like a mortgage.
So what if your
income is still growing, and you would like to have more money to spend in
retirement than you do now? I’m with you. My own retirement replacement ratio
is 110%. It is absolutely ok to use a higher retirement replacement income in
your calculation as long as you believe you will realistically make more than
that amount at some point in your career. After all, we want to make sure you
have money to enjoy prior to retirement!
Crunch Those Numbers
Now that you have
determined your input values, you can let the calculators do the work of
figuring how much your retirement account needs to be at retirement, and how
much you need to save now to make it happen.
Three
free internet calculators I recommend using:
https://isc.nwservicecenter.com/iApp/isc/rpt/launchRetirementTool.action
(Nationwide) I like that the output screen allows you to play around with the
numbers and see how changes to the variables affect the outcome.
https://www3.troweprice.com/ric/ricweb/public/ric.do
(T Rowe Price) This calculator has won numerous awards, although I wish it took
into account income growth.
http://www.dollartimes.com/calculators/retirement.htm
- This one shows your account growth and then withdrawals year by year.
I list three
because I am not completely satisfied with any of the free calculators I’ve come
across. Try using all three to see where the differences lie. If your annual savings number is out of your reach, start with what you can afford and make a commitment to increase it by 5% or 10% each year.
The most important thing
to remember is that calculating your retirement goal should be an annual habit,
not a one-time project. Your life will continue to change significantly prior
to retirement, and as long as you are proactive with your retirement funds they
will be there when you are ready to retire, regardless of life's surprises along
the way.
All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.
