Doing the math to calculate your retirement savings goal
By Gary Foreman
The New Frugal You
Dear New Frugal You,
turn 50 this year. So I'm beginning to think about retirement. My question is a
simple one, but no one seems to be able to give me a clear answer: How much
money will I need to save for my retirement? Is there some way to calculate it? -- Zach
right. By age 50 you definitely should have a retirement plan in place, which
isn't always easy, especially in the current environment. Let's see if we can't
set up a framework to help you determine how much you'll need to save for a
begin with a caution: There is some math involved. If all you want to do is just plug in
numbers into a retirement calculator, that's easy.
But I'd encourage you to continue reading so you understand how the numbers can
affect your results.
first task is to estimate how much income you'll want. Then we'll figure out
how much savings you'll need to earn that amount of income.
your income needs in retirement isn't an exact science. You can find experts
suggesting between 50 percent and 100 percent of your pre-retirement income. Part of
the huge variance is due to the variety
of retirement lifestyles. Some retirees are content to stay home and tend their
gardens. Others take off on that long-postponed world tour.
your best guess as to how your desired retirement lifestyle will affect your
income needs. Tend to err on the high side.
make up some numbers to work with. Suppose that your current income is $75,000
per year. And you think you'll need about 65 percent of your current income to
enjoy retirement. Multiply your current income by that percentage ($75,000 X
.65 = $48,750). To make the illustration easier, let's round up to $50,000.
that means that you'd need $50,000 per year in retirement. But, that's in
today's dollars. What about inflation? Even minor inflation can raise prices
significantly over time.
can use a simple savings calculator
to adjust our income target for inflation. In this case we'll enter $50,000 as our
starting amount with no additional monthly deposits. Let's choose 3 percent for
"annual interest," which will represent inflation. And 20 years until
we want to retire. The calculation works out to $91,037. That's how much
inflation-adjusted income we'll need.
we'll need to estimate how much of that $91,000 (yes, I've rounded again) will be provided by Social Security.
Not an easy question. The trustees of Social Security say that the trust fund
will be empty by 2033. That doesn't mean the system will be out of money -- tomorrow's workers will still be paying in -- but it does mean that today's payout levels are questionable. Either benefits will have to be cut or taxes raised -- iffy propositions in today's political world. So you may decide to only include a portion of SS
promised benefits in your calculation.
call to Social Security (800-772-1213) or a visit to its website will get you a form to find out your
expected benefits. We'll use the 2013 maximum benefit of $2,533 per month or
$30,400 per year.
we'll subtract any private pensions that you may have earned. You'll probably
need to contact the HR department of your employers (past and present) to find
out what you can expect to receive. We'll assume that you'll get $1,800 a month
or $21,600 per year.
now have the three big pieces to our puzzle: how much income we'll need, how
much Social Security and private pensions will provide. Subtract the Social Security and
private pension from your total. In our case that leaves ($91,000 minus $30,400
minus $21,600 = $39,000).
we'll need to save up enough money in our IRAs, 401(k)s and savings to earn us
$39,000 per year.
have one last question to answer. How much do we need to save to give us that
$39,000 per year? Again you'll get different estimates as to how much income you
can take each year without eroding principal. We'll choose a medium estimate of
4 percent per year.
our annual income desired by 4 percent tells us that we'll need to save $975,000.
that you've survived the math (which wasn't really all that hard), let's look
at some of the assumptions.
know that experts will say that this is a simplified version. They're
right. For one thing, we didn't adjust Social Security benefits for inflation.
We could have easily increased them just like we did our income requirements.
And, it's also possible that our pension benefits will be adjusted for
estimate was meant to be simple. In part because we have some big assumptions
that go into any retirement projection. Inflation rates for decades. Investment
earning rates. The future of Social Security. Minor changes in any of those
rates extended decades into the future make a huge difference. So trying to be
overly accurate just isn't possible. This method is fine for getting you in the ballpark, though it won't guide you to your individual seat.
key thing is to begin saving now. No matter how accurate or inaccurate your
estimates are, you'll save more if you start sooner. So starting to save now is
always the right answer.
can recalculate as you update your assumptions over the years. You'll have more
info to go on. Your calcuation will become more accurate and as you near
retirement you can refine your expectations.
whether you're 25 or 50, the time to start saving for retirement is now!
See related: A simple retirement plan, Retirement in sight? Balance your risk tolerance, need for growth
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Published: May 18, 2013