Tips and Tools for Planning Your Retirement
If one of your dreams is early retirement—or maybe just a comfortable retirement when the time comes—you’ll have a much better chance of realizing your goal if you have a game plan. In order to be able to retire at any given age, you will need the financial means to do so, and it’s hard to hit the target if you don’t know what you’re aiming at. Thus, the first step in designing a plan for retirement is to determine how much you expect to need in your retirement account when the big day arrives. It may not be as much as you think—or it may be more.
One factor that must be taken into consideration is inflation. An item that costs $20 today can cost you considerably more when you enter your retirement years, as the table below indicates:
|Amount $20 of Groceries Will Cost When You Retire|
|Inflation Rate||Years to Retirement|
|2%||$ 24.38||$ 26.92||$ 29.72||$ 32.81||$ 36.23||$ 40.00||$ 40.16|
|3%||$ 26.88||$ 31.16||$ 36.12||$ 41.88||$ 48.55||$ 56.28||$ 65.24|
|4%||$ 29.60||$ 36.02||$ 43.82||$ 53.32||$ 64.87||$ 78.92||$ 96.02|
|5%||$ 32.58||$ 41.58||$ 53.07||$ 67.73||$ 86.44||$ 110.32||$ 140.80|
So, for example, if you are 25 now and want to retire in 30 years at age 55, and the average annual rate of inflation over those 30 years is 4%, you can expect your grocery bill to be more than three times higher when you retire, all else equal, since $20 today translates to $64.87 in 30 years, given a 4% inflation rate.
What’s a reasonable rate to assume when you’re trying to determine how much money you will need when you retire? That’s anybody’s guess. The inflation rate is calculated as the percentage change in the Consumer’s Price Index (CPI), which measures the change in the cost of a hypothetical basket of goods purchased by the average consumer.
To illustrate, let’s assume an average annual rate of inflation of 4% and that you currently earn $50,000 a year. We’ll further assume that you are quite comfortable with your present lifestyle and believe that the same amount of income, adjusted for inflation, will enable you to live comfortably during your retirement years. This means you will require approximately $162,170 a year (= $50,000 x (1.04)30, for you math jocks) after you retire to live in the style to which you’ve become accustomed. Lest you gloss over the fact and become too exuberant, let me emphasize that this is $162,170 a year, not the total you need to have accumulated by retirement. If you plan to live to age 90, 35 years after your retirement at age 55, you will need to have over $5.6 million dollars under your mattress, assuming zero inflation after you retire. Before you get discouraged, however, let me quickly point out that this also assumes you won’t be earning anything on the money you've accumulated by retirement age, which, I hope, is a bad assumption.
There is a very useful tool on the Financial Investment Regulatory Authority’s (FINRA) website that enables you to calculate how much you must save annually to achieve your retirement goals, given various assumptions, including the expected rate of inflation, your current and estimated future tax rates, and how much you expect to earn on your investments. You’ll find it online here. The tool makes it easy to see how a change in some of the inputs can affect the amount you need to set aside each year to reach your target.
For example, using the calculator on the FINRA website, I assumed a current savings balance of $5,000, entered $50,000 as the annual retirement income desired, and assumed that there would be no other source of income after retirement. I entered 25 as the current age, 55 as the retirement age, and specified that withdrawals should continue until age 90. Using the default numbers provided for the annual return on investments (6%), the inflation rate (4%), and the current and expected future tax rates (28% and 25%, respectively), I determined that an annual savings of $44,379.48 would be necessary. This could be difficult to achieve, given a current annual income of only $50,000.
What to do? You can abandon all hope of retiring at age 55 and instead enter 65 for the retirement age, leaving all the other entries the same. This results in an annual savings requirement of $23,248.20. But there may be an even happier solution. In order to retire at age 55 on $50,000 a year, you only need to set aside $14,023.37 a year if you assume an average annual return of 10%, instead of 6%, on your investment portfolio. And 10% is not an unreasonable expected return, given that, calculated from the point of its introduction in the 1950s, the average annual return on the S&P 500 Index, a portfolio of 500 of the largest U.S. stocks, exceeds 10%.
So, you now have an annual investment goal of approximately $14,023 and a 10% return to target. You know what to aim for—at least in the short-term. It’s wise to remember that the target is not stationary. Changes in your life and in the economy can affect both your needs and your expectations, which is why it is prudent to review your plan annually to determine if the assumptions you have made are still valid and make any necessary modifications.