Setting Retirement Goals: What's Your Number?
Of all the concerns that advisors are presented with in the meeting room, "I don't know if I have enough money to retire" has to be the most prevalent. Even the strongest "savers" have little understanding of how to determine the final retirement amount which they should aim to generate. The reason why? It's complex. Things change. Most investors are not aware of all the factors that are embedded in the calculations for the projected retirement income plan that your trusted advisor is creating for you. There is surely a way you can do this without all the fancy financial planning software that professional planners use. Planning software is very useful in structuring the data and generating pretty charts, graphs, schematics and diagrams and all that goes into the planning that paints your comprehensive retirement picture. However, without the most intricate piece of information -- your income goals, a comprehensive plan isn't possible to construct. Your retirement income is the linchpin that connects you to your retirement engine -- the wealth you've accumulated during your working years. (For tips on increasing your retirement income, see article: How To Retire With More Money.)
In order to accurately project that final number that quantifies what you'll need, every investor should examine his or her starting point, which is his or her present lifestyle, and make some assumptions about how things may change in the future. Starting from the beginning, let's take a look:
1) Current household income: What are you currently making as a household before and after taxes? (You'll need to estimate your income for your projected retirement date.)
2) When do you plan on retiring? Be specific. Don't just say 55 because that's when your friend's sister's cousin's brother retired. Time is one of the most important factors when projecting your final number. (See article: Will The Retirement Age Change In The Future?)
3) Consider with your spouse what retirement goals you have and be realistic. Goals are very important during the planning phase in which you anticipate future income-generation and saving for specific purchases, etc.
4) Budget: now and later -- no exceptions. You'll need to assume what your expenses will be down the road, and your current budget is the best way to understand how you'll be using money in 10 or 15 years. Don't forget healthcare and education costs. The experience of many retirees shows that people spend more money in that 1st year of retirement since they are no longer occupied during the day. Having an established budget before you retire can help you avoid overspending.
When you've calculated your annual budget, your planner can reasonably predict what amount of money you'll be living on during retirement. Now, in the most general terms, you have an annual retirement budget that is approximately 80-100% of your current income depending on your desired lifestyle. From here it's pretty easy. Your total annual income after taxes is added to your projected future annual income tax (with the future income tax rate being projected based on your current marginal income tax rate). An example of a formula for calculating what you'll need annually is as follows: Annual Income ($100,000 (after tax)) + Future Tax Amount (25% (Fed) or $25,000) + 4.25% or $4,250 (State of MI) = Projected Income Needed ($129,250 (before taxes)). Normally you would include average inflation in your calculation, but for our purposes we're just looking at a general number.*
The next thing you'll need to do is calculate the total assets needed to support two to three decades of income. You'll calculate this by dividing the projected income needed by a suggested sustainable withdrawal rate for your portfolio and risk tolerance. For our example, we'll use 4.5%. So then, $129,250 / 4.5% = $2,872,222 total assets needed.*
The Bottom Line
This is a rudimentary way to project the retirement amount you'll be aiming to generate and get you on a path toward your goal as quickly as possible. There are plenty of other factors you'll need to consider. The calculations in this illustration do not include average inflation or Social Security income. Both are vital to generating a comprehensive retirement picture for any investor. Of course, you should always consult with your advisor (tax and investment) before attempting to form a firm goal. (For related reading, see article: Is Your Retirement Plan On Track?)
*This is a hypothetical example and is not representative of any specific investment. Your results may vary.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.