Determining Retirement Needs - Retirement Needs Analysis
Leimberg, Satinsky, Doyle & Jackson, Tools & Techniques of Financial Planning, 7th Edition
Retirement Planning Basics, Investopedia.com
I. Assumptions for retirement planning
One of the primary difficulties of retirement planning centers around the fact that so many assumptions must be made. These include assumptions about interest rates, inflation, expected rates of return, life expectancies and other factors. Small changes in any of these factors can have a major impact on the financial security of a retiree.
The rate of inflation can have a huge effect on a retiree's standard of living, as it erodes the buying power of income that, in large part, may be fixed. A realistic projection of future inflation rates is needed to calculate the income and assets needed to retire.
Inflation in the
has varied dramatically by decade, ranging from -1.94% in the 1930s to 7.09% in the 1970s. The long-term average from 1913 to 2006 was 3.43%. Since 1990, inflation has averaged 3% or less. (For more, see the article All About Inflation.) United States
B. Life expectancy
Life expectancy - the age until which a person is expected to live - is a second critical factor in determining how much money an individual will need to set aside for retirement.
For retirement planning purposes, the question is how long will a person live from the time he or she leaves the workforce. It is impossible to know exactly when a person will die, but an individual does have some control over when he or she will stop working.
Working longer will reduce the number of years in retirement and, therefore, reduce the level of assets needed to fund that retirement.
Individuals in the
are living longer than ever, which means they are living longer in retirement. An individual born in 1900 had an average life expectancy of 47 years. For a child born in 2004, life expectancy is nearly 78 years, according to the Centers for Disease Control and Prevention's United States for Health Statistics. National Center
Also, the longer one lives, the greater their chances of living a longer-than-normal life. Somebody who reached age 65 in 2004 had an average life expectancy of nearly 84 years.
Life expectancies vary by gender and race, with women in general living longer than men, and white Americans living longer with black Americans.
For more on life expectancy, see the
- Joint Life Expectancy - For couples, the average number of years until the second person's death is longer than the individual life expectancy of either person alone. This means using whichever person's life expectancy is greater will result in underestimating the retirement needs of a couple.
for Health Statistics. National Center
The type of lifestyle an individual or couple seeks to live in retirement will greatly affect the level of retirement assets and income needed. Factors to consider:
- Travel plans
- Part-time employment plans
D. Total return
The rate of return an investor will earn while saving for retirement and then in retirement also require assumptions about the unknown. Typically, planners will rely on historic rates of return for various types of portfolios when drawing up a retirement plan. To be on the safe side, many planners use conservative estimates that may be a couple percentage points below historic rates of return.
For a 100% stock portfolio, the average rate of return is about 10%; many planners will use estimates of 7% to 8%. (For more, see Retirement Planning Basics.)