December 17th, 2010
Veronica from Venice Beach writes:
How much money do I need to have to retire?
This is a popular question that needs very personal attention. With that in mind, here are a few important considerations.
First you must estimate your income needs in retirement. The easiest starting point would be your current expenses adjusted for inflation. If you have many years until retirement, your assumption for inflation rate will be very important. Long term inflation has averaged about 3.5% per annum. Don’t forget to compound! (i.e. the inflation adjustment for 10 years using that rate would be 1.035^10 – 1 = 41%, not 35%)
Next you will need to estimate other future sources of income. If all goes reasonably well in the US, you will get some type of Social Security. This will vary based on how much you have put in over the years, and the age at which you begin to take payment. If you are entitled to a Pension, this should also be considered. As you may be aware, both Social Security and a variety of State Pensions are under duress. So, while these are typically expected as part of retirement income, there is always some possibility that they payout less by the time some of us reach the age of maturity.
The difference between what you earn from Social Security and Pension and what you will need to spend in those years must come from your investments. If your investments are expected to earn 8%/yr and you give up 2.5% to Uncle Sam (unless assets are in a ROTH IRA), and another 3.5% for inflation, you are left with 2% to withdraw and continue to allow inflation adjusted future withdrawals. This means that you would need 50 times your anticipated income withdrawals in retirement! Keep in mind that this is a conservative way to view things. Many experts use 25 times as a rule of thumb.
There are so many scenarios to consider. We have provided a simple spreadsheet calculator to help you better assess your situation.
For Excel 2007 and 2010: Retirement Savings 12-17-2010 2007-2010
For Excel 97 and 2003: Retirement Savings 12-17-2010 for 97-2003
The orange cells allow you to play with different assumptions to see how they impact your retirement. Here are a few notes to consider.
Inflation – If you have many years until retirement, the inflation assumption is more important. It also may be more likely to follow longer term inflation history. In any shorter period of time inflation can vary materially.
After Tax Growth Rate – If most of your assets are already in a ROTH IRA, you will not pay taxes upon withdrawal. Other accounts will be subject to taxes on most investment vehicles.
Social Security – There is a lot of speculation on the future of our Social Security benefits. Some pundits speculate that benefits will be reduced. Others believe that they will be eliminated for wealthy individuals. Still others think that benefits will be delayed as life expectancy has increased since the inception of the program. If Social Security is a large part of your expected retirement income, please consider these risks when planning your future.
Pension – Some pension funds (specifically defined benefit pension) have been scrutinized for not having enough assets to cover expected future liabilities. If pension income represents a material part of your retirement income, please examine the structure of your benefits and assess the risk accordingly (or seek assistance from your professional advisor).
Expected Retirement Age – Play with this number. Another year of savings without withdrawal can have a material impact.
This is meant to be a fun, but simple, tool to help you examine your finances in retirement. Your individual circumstances may require more in depth analysis. Please consult your financial advisor to discuss your specific circumstances.
We hope that helps and provides fodder for discussion. Please let us know if we can be of further service!
The Friedenthal Financial Team
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