It’s a question we should have an answer to. What’s your retirement number, how much money do you need to live comfortably through retirement.
It’s a complicated question, and scares most people (it scared me :)) But have no fear, Excel to the rescue! You can build a rudimentary model to at least get a good idea of your number. All values in the model are post-tax numbers. Tax effects are for another post!
Some base assumptions:
- Retirement age is 65
- Life expectancy is 80
Lets break it down.
How much money in today’s dollars do you think you need each year in retirement? This is the first important estimate. What kind of income do you need in retirement? $30K/year, $40K/year? This sets your living standard – choose this number wisely.
Next, you have to make some judgements on the inflation rate. Inflation causes your money to get less valuable every year so you have to adjust the amount of money you need upwards, to account for the inflation component. Adjusting for inflation is to ensure that the $70K a year you expect today is reflected accurately for the future in retirement. In simple terms, $70K/year today is actually equivalent to $236K/year 35 years from now with a 3% inflation rate.
Next you have to estimate health care expenses. A recent survey indicated that in 2011 the cost of premiums for two people retiring today is roughly $10K/year. I have made a conservative estimate here and grossed up the numbers in the article. You have to assume a growth rate of this premium as premiums appear to always be on the rise. This is very similar to the inflation number and I have estimated growth rate to be 2X inflation.
Add both these up. These are your expenses. This is the number you need to have at a minimum for retirement.
This is your number!
For example the model spit out $5.6M as a number for the following assumptions.
- Expenses $40K a year in today’s dollars
- Medical expenses growing at 2X inflation.
- Inflation at 3%.
How well prepared are you for this number. What do you need to do hit this number? Again Excel to the rescue – estimate your revenues!
How much money have you saved today? How much money do you expect to additionally save each year going forward (till retirement)? How much money will you make from your investments? Make an estimate of how much you expect to earn on your investments. Split the investment return two components – pre-retirement and post retirement return. Post retirement your investments still earn money, but you will gradually likely move to safer investments which means you will have a lower rate of return. Add all this up and this is your revenue number.
Now for the punch line. Subtract expenses from revenue, If you are in the RED before 80, you are not prepared. Tweak the various parameters in the model that you have control over (current savings and incremental savings each year) to see what you need to do.
What do you guys think, how do you calculate your number? Any refinements to this model and its assumptions? If you need a copy of my spreadsheet model drop me a note in the comments.