In this tutorial, you will learn how to go about determining your retirement needs. You will learn the value of setting goals and cash flow management. You will also learn how to obtain valuable information about your Social Security Benefits and company retirement plan.
This tutorial contains the following lessons:
HOW MUCH WILL YOU NEED TO RETIRE?
In order to answer this question, you must sit down and picture retirement in your own mind. Retirement means different things to different people. For some, retirement means being sufficiently financially independent to travel and relax 24 hours a day. Others may view retirement as a "career change." However you view retirement will help you determine how much you will need to retire. So let us help you paint that picture.
Will your lifestyle change dramatically in your retirement vision? Or will you, like most persons, continue doing the things you currently do, trading "work" for leisure and volunteering? Will you incur more expenses in retirement for leisure and travel? Or will you prefer to spend more time with your children, grandchildren and family?
Many "experts" claim that the average person needs 65% to 75% of their pre-retirement income. You can get a good idea of how much you need by examining your current lifestyle and adjusting it for your retirement vision.
Let's see how you go about evaluating your current needs.
WHAT ARE YOUR CURRENT NEEDS?
The best way to determine how much you will need in the future is to know what you need right now. Some people think they need their current income. That is not true. You need "cash inflows" to cover your current expenses, taxes, and savings for future needs. In retirement, you will need cash inflows to cover expenses and taxes only. You may wish to continue saving for your heirs, but that is not a need. Your expenses may change if you change your lifestyle, and your taxes will change depending whether your cash inflows are from "income" or a return of investment.
Read below to see how to organize your expenses and manage your cash flow.
WHAT EXPENSES WILL YOU HAVE IN RETIREMENT?
Let us start by looking at our expenses. In retirement, you will have the same expenses as you do today. You should make a list of the following expense items and the amount you currently spend for them. You may wish to tweak them if you envision a lifestyle change down the road.
| Housing: (rent, mortgage, taxes, utilities, repairs, insurance) | 20 % | __________ |
| Groceries: (food, household supplies, dining out) | 11 % | __________ |
| Personal: (clothing, dry cleaning, personal care) | 5 % | __________ |
| Automobile: (payments, maintenance, gas, commuting, insurance) | 9 % | __________ |
| Un-reimbursed medical expenses and medical insurance payments | 4 % | __________ |
| Insurance: (life, disability, accident, and umbrella) not paid by employer | 4 % | __________ |
| Recreation: (vacation, clubs, subscriptions, theatre, books, etc) | 5 % | __________ |
| Gifts to charity and others: (weddings, birthdays, holiday) | 2 % | __________ |
| Interest on consumer loans and credit cards | 4 % | __________ |
| Other: (in case we missed anything) | 8 % | __________ |
The rest went to taxes and savings.
*AV= the percent of gross income spent by "the average couple" in their 60's.
HOW WILL INFLATION AFFECT YOUR RETIREMENT?
Of course, the expenses you listed above are in today's dollars. To get better idea of what they will be when you are ready to retire, you should adjust them for inflation. Unfortunately, no one knows the future rate of inflation, so you are on your own to make a guess. The table below shows how much to multiply your expenses by for different rates of inflation.
For example, if you have 15 years until retirement and expect a 3% to 5% inflation rate, you should multiply your current expenses by the inflation table factor 1.80.
A current need of $5,000 per year translates to a requirement of $9,000 per year 15 years later - just to stay even! (5,000 x 1.80 )
| Years To Retirement Current |
Annual Rate of Inflation |
|
3% - 4% - 5% |
| 5 Years |
1.16 - 1.22 - 1.28 |
| 10 Years |
1.34 - 1.48 - 1.63 |
| 15 Years |
1.56 - 1.80 - 2.08 |
| 20 Years |
1.81 - 2.19 - 2.65 |
| 25 Years |
2.09 - 2.67 - 3.39 |
| 30 Years |
2.43 - 3.24 - 4.32 |
Inflation has been under 4% over the last few years. However, we have experienced periods of double-digit inflation (in the 1980s). Once you have adjusted your expenses for inflation, you should add them up. That is how much cash inflow you need in retirement. So where are you going to get this money?
WHAT WILL SOCIAL SECURITY AND YOUR PENSION PROVIDE?
If you have been working all your life contributing the maximum to the Social Security system, you could receive over $13,000 at your normal retirement age ($20,000 for a couple). Of course, these figures will be adjusted for inflation. If you choose to start receiving your benefits before your normal retirement age, you would receive a reduced benefit. To find out how much you are entitled to, you should send for a "Request for Earnings and Benefit Estimate Statement" from the Social Security Administration (SSA). You can obtain a free form from your local SSA office. Their telephone number is listed in your White Pages.
If you worked for an employer that has an employee retirement plan, you may be entitled to retirement benefits. There are different kinds of plans in use today. A typical "defined benefit" plan may provide as much as 50% or more of your final average salary at normal retirement age (as defined in the plan document). A "defined contribution" plan will provide you with a lump sum at retirement that you can convert into retirement income.
You should contact the personnel or human resource department of your employer to get an estimate of your retirement benefits, if any.
Your Social Security and retirement benefits will only provide a portion of the cash inflows you will need for your retirement vision. The difference will have to come from your own savings. You can use the table below to help determine how much you need to save.
WHAT IS AN ANNUAL RETIREMENT ANNUITY
An annuity is a reverse loan. It is a systematic withdrawal (cash flow) from an investment made periodically as a return of interest and principal. You deposit a lump sum and withdraw the same amount each year until it is all paid back.
When you subtract your projected retirement expenses from your expected retirement income, you may find you have a negative cash flow. This negative cash flow is your "retirement cash flow deficit." Once you know what your retirement cash inflow deficit is, you can determine how much you need save to make up the difference.
For example: Let's say you added up your retirement expenses (adjusted for inflation) and your anticipated Social Security and pension benefits and you still need another $42,800 before taxes (retirement cash flow deficit). You estimate that you will need this inflow for 20 years. You expect your investments to average 10% per year.
| Years Of | Assumed Annual Percent Earnings Rate (per $1,000 savings) |
| Annuity | 5 | 7 | 8 | 9 | 10 | 12 |
| 5 | 220 | 228 | 232 | 236 | 240 | 248 |
| 10 | 123 | 133 | 138 | 143 | 148 | 158 |
| 15 | 92 | 103 | 108 | 114 | 120 | 130 |
| 20 | 76 | 88 | 94 | 101 | 107 | 120 |
| 25 | 68 | 80 | 87 | 93 | 100 | 114 |
| 30 | 62 | 75 | 82 | 89 | 96 | 111 |
You can use this chart to help calculate how much you need to accumulate before retirement by dividing the annuity amount (42,800) by the annuity table factor 107.
|
Annuity |
|
$42,800 |
|
|
| Savings= |
------------ |
X 1000= |
------------ |
X 1000= |
$400,000 |
|
Table factor |
|
107 |
|
|
You would need to accumulate another $400,000 to generate an annual retirement annuity of $42,800 per year. Now let us put it all together.
COULD THIS BE YOU?
Here is our average couple that plans to retire in 15 years. Their current estimated expenses for retirement are shown. They adjusted the expenses for inflation.
| Housing: (rent, mortgage, taxes, utilities, repairs, insurance) | 20 % | 15,732 | 32,722 |
| Groceries: (food, household supplies, dining out) | 11 % | 8,653 | 17,997 |
| Personal: (clothing, dry cleaning, personal care) | 5 % | 3,933 | 8,181 |
| Automobile: (payments, maintenance, gas, commuting, insurance) | 9 % | 7,079 | 14,725 |
| Un-reimbursed medical expenses and medical insurance payments | 4 % | 3,146 | 6,544 |
| Insurance: (life, disability, accident, and umbrella) not paid by employer | 4 % | 3,146 | 6,544 |
| Recreation: (vacation, clubs, subscriptions, theatre, books, etc) | 5 % | 3,933 | 8,181 |
| Gifts to charity and others: (weddings, birthdays, holiday) | 2 % | 1,573 | 3,272 |
| Interest on consumer loans and credit cards | 4 % | 3,146 | 6,544 |
| Other: (in case we missed anything) | 8 % | 6,293 | 13,089 |
They estimate that they will receive about $75,000 in pensions and Social Security Benefits. They estimate they will need another $42,800 to cover their expenses and taxes. Using the annuity table and formula:
|
Annuity |
| $42,800 |
|
|
| Savings= |
---------------- |
X1000= |
----------- |
X1000= |
$400,000 |
|
Table factor |
|
107 |
|
|
Thus they should estimate they need to save $400,000 more before retirement.
This concludes this introductory tutorial on determining your retirement needs. How much do you need to save?
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