Retirement IncomePosted on September 3rd, 2010 William No comments
This website is all about saving for retirement, and we tend to assume that more money is better. However, we obviously can't save an unlimited amount of money, so it's important to assess your needs and figure out how much retirement income you realistically need to live on.
There are really several numbers involved here. The first two are simple: how much money per year do you need to provide for your basic needs, and how much do you need in order to live the way you would like? There's a big difference between being able to eat rice and beans for dinner and being able to afford steak; while the first number if the minimal amount you need to survive, the second number is your goal. (Unless you're vegetarian, but you get the idea). The second set of numbers you need is the amount of money required so that, in a conservative investment, the interest will be enough to provide the required amount of retirement income indefinitely. However, this oversimplifies things a bit because not all of your retirement income has to come from investments; you might be eligible for social security or have a pension or annuity that, while not available for investment, still provides part of your living expenses each month.
An annuity is an example of an asset: something that will generate income for you. Another example would be a paid-off rental home. In fact, any real property that is worth more than you owe can be considered an asset if it has the potential to make you money; for example, you could take out a reverse mortgage on the home you own in order to provide money for your retirement.
If all sources of income will not meet your needs, then you have three options: cut down on your standard of living, work a part-time job while you're retired, or work for longer before you retire. Working an extra year adds more time to your retirement than you might think; that's one extra year's worth of expenses that you haven't withdrawn from your retirement fund, another year's contributions to said fund, and another year for the money in the fund to continue to grow. As such, working for a year or two longer than expected can give you a very nice improvement in your retirement income.
So how much money do you actually need? Here's a quick way to get a rough estimate. First, figure out how much you'd need to live the lifestyle you want now. Next, adjust that amount for inflation; to be safe, we'll assume an annual inflation rate of 4%, which should cause us to overestimate how much you'll need; the multiplier is 1.04 to the power of x, where x is the number of years until you plan to retire. For example, if you expect to retire in 30 years, go to Google and type in (1.04)^30; Google tells us that this is 3.24, which means that for every dollar we'd need now, we'll want to have $3.24 in retirement income. (A lower inflation rate leads to vastly lower numbers, of course; 2% means only needing $1.81, while 3% means $2.43; that last number is probably the most accurate). Suppose you believe you can live the way you want to on $60,000 per year in today's dollars; with three percent inflation, that means you'll need $145,800 per year in retirement income.
Now, suppose you have no income-producing assets and need to live entirely off your savings. You can calculate this two ways: either for your savings to last for a certain number of years, or to last indefinitely. Obviously the latter is much easier! For your savings to last indefinitely, you need to be drawing down less than the growth in your portfolio each year. (Why less? If you withdraw the entire growth, you'll keep getting the same amount each year, which means your income in real dollars will shrink with inflation). Assume you have a large, diverse portfolio that returns a steady 5% each year; that means your break-even point is twenty times your desired annual income, or $2,916,000. Round that up to three million dollars and you'll be reinvesting a bit over four grand per year to help beat inflation. (Note that if you delay retirement for just one year, as we previously discussed, the extra money will more or less cover inflation).
Three million dollars sounds like a lot of money, but it's quite achievable over that time span. By following the tips on this site, you should be able to fully fund your retirement plans and insure that you have the amount of retirement income you desire.