The following is a post by MPFJ staff writer, Toi Williams, who is a professional personal finance blogger of Fine Tuned Finances. She has backgrounds in personal finance, sales, and real estate.
Retirement planning is a very important part of your future financial security, but it is often the most difficult part of financial management to accomplish. One of the main reasons why it is so difficult is because there are a lot of unknowns that have to be estimated to arrive at a good number to set as a retirement savings goal. When you are in your twenties and thirties, it is hard to imagine what your life will be like when you are in your sixties and seventies.
Fortunately, there is a formula and process that you can use to calculate how much you would need to save to maintain your current lifestyle during your retirement years.Â
Step 1 – Calculate The Cost Of Maintaining Your Current Lifestyle
The first thing you should do when calculating how much you will need to save for retirement is calculate how much it would cost you to maintain your current lifestyle in your retirement years.
The cost of maintaining your current lifestyle may be slightly lower during your retirement years because there will be some expenses that you will no longer have to pay. For example, you will no longer have to pay the various costs associated with being employed, like purchasing business clothing or transportation costs to and from work.
A good assumption would be that you would need about 80 percent of your current salary to maintain your current lifestyle in retirement. So, if you make $70,000 per year now, you can estimate that you would need $56,000 per year during your retirement. On paper, the calculation would be 70,000*0.8=56,000
Step 2 – Add In Inflation Increases
When doing their retirement planning, many people forget that inflation will have an effect on the future value of their money. Because of inflation, one dollar today does not have nearly as much purchasing power as one dollar had thirty years ago. Thirty years from now, a reasonable assumption would be that one dollar would buy much less than it does today.
To compensate for the inflation that will affect the cost of goods and services in the future, you should add in inflation increases of 3 percent per year for every year up until you expect to be retired. If you are 35 years old now and you expect to retire when you reach 65, you will have 30 years of inflation to contend with when you retire. Using Google’s search bar, the calculation would be 1.03^30, which totals 2.4273. This number should be multiplied by the previously calculated amount ($56,000) to arrive at the amount that you would need to maintain your current lifestyle during your retirement years after inflation, which would be $135,929 per year.
Step 3 – Subtract Your Retirement Income Payments
Many people will receive retirement income payments during their retirement years that will be used in place of savings for spending.
These payments may include payments from the Social Security Administration, pension payments, payments from annuities or other savings vehicles, and any income you expect to receive during those years. These estimated retirement income payments can be subtracted from the inflation-adjusted cost of maintaining your current lifestyle, allowing you to reduce the overall amount that you need to be saving. For example, if you expect to bring in $35,000 per year during your retirement years in social security payments and other income, you can reduce the amount that you will need to save to $100,929 per year for each year of retirement.
Step 4 – Determine How Long You Will Be Retired
Determining the amount of time that you will be retired is where the calculation gets tricky because you have to estimate the age you will be when you retire and the age you will be when you die. Although no one knows what will happen in the future, many people in good health can reasonably assume that they will work until they are 65 and will live until they reach their mid-eighties, an estimate of roughly 20 years. When the amount that you need to save each year is multiplied by the number of years that you expect to be retired, you get the amount that you would need to save before you retire. In our example, the person would need to save $2,018,580 to ensure that they have enough money to live comfortably during retirement.
While $2,018,580 sounds like a lot to save, if you were to get started now, you would have thirty years to try to save the amount. You will also be taking advantage of compounded interest on your savings, helping your money grow faster and reducing the amount you must divert from your paychecks. The sooner you start saving, the more compounded interest you will earn over time, allowing you to reach your goal more quickly than you would think. You can also increase your retirement savings by diverting bonuses, income tax refunds, and other windfall payments into your retirement accounts.
How about you all? Have you made a plan and figured out “the number” you need to save for retirement? What have you experienced while trying to reach your retirement saving goal?
Share your story with us by commenting below!Â
***Photograph courtesy of http://www.flickr.com/photos/fishyone1/9559556453/
