Exactly how much money you need for retirement is difficult to give a definitive answer. As with most things there are unknowns such as unexpected health complications and exactly how long you will be around before you kick the bucket. We can get a general idea though by making some assumptions. The assumptions include:
- What age you plan to retire,
- What age you are now,
- Your living expenses when you retire,
- Expected inflation, and
- Expected interest earned on retirement savings.
What is my retirement age?
In the United States the current average retirement age is 61 years old. The average retirement age has steadily increased over the years from 57 years old in 1991 (from 2014 Gallup poll).
The Gallup poll suggests that the average retirement age will continue to increase to a little past 65 years old. Of course there is not set age at which you must retire from working. If you set the goal to retire early, and make the necessary arrangements to do so, that is your opportunity/challenge.
What are my living expenses when I retire?
Your estimated cost of living is dependent on the type of lifestyle that you plan on having. Another way to think about it is “what percentage of my pre-retirement income is needed to fund my retirement years?” Consider how the following will impact the amount of money you will need each month:
- Mortgage. Do you plan to have a mortgage payment?
- Savings. How much do you spend on saving for retirement now? Once you retire, you won’t be saving into a retirement account…you’ll be spending it.
- Health care. Many enjoy health care subsides from their employer. Once you retire, these won’t be available. Generally, health care costs increase with age.
- Entertainment. Retirement will bring more opportunities to choose what to do with your time. Whether is it traveling or other projects; take into consideration how much you plan to spend.
Many give recommendations that you should plan on spending about 70% – 80% of your per-retirement income during retirement. If you project a 3% raise each year, your can determine your projected yearly income at retirement. Multiplying this by 75% will give you a ball park number of how much you will spend each year during retirement. Ultimately your living expenses will be limited by the actual amount of money that you have saved when you retire.
Inflation is the general cost increase of goods and services over time. It may sound great if your boss promises to give you a 3% raise each year. If the cost of living increases 6% every year, however, the 3% raise isn’t as great as it once sounded. The US dept. of Labor has been tracking inflation (consumer price index) in the U.S. for decades. Below is a graph showing the average yearly inflation rate (%) each year from 1914 through 2012. The red line is the average inflation rate for the time period on the graph.
Interest on Retirement Savings
Interest is the cost of borrowing money. The lender makes money from interest, and the borrower pays interest. Having a 401(K) or other retirement savings account allows you to earn interest on the money that you give to borrowers asking for money. There are many different types of investments. A very common investment for 401(K) retirement is a mutual fund. The S&P 500 (Standard & Poor’s 500) is an index of 500 large companies on the stock exchange. Following the S&P 500 average is a good representation of the stock market, and can give you an idea of the interest rate that has been earned on retirement 401(K) accounts. Below are graphs of the average annual interest rate return of the S&P 500. The red line is the average interest rate for the time period on the graph.
The average annual interest earned from 1910 to 2012 has been 11.4%. In the past 52 years (1960 – 2012) the average yearly interest earned was 11.0%. Investing is a risk. This can be seen by the highly volatile annual average rate of return in the graphs above. The fact is nobody can say that mutual funds will continue to yield of 11% return on investment. Based on past performance, however, mutual funds have consistently averaged a higher rate of return than most other investment techniques.
Calculating how much you need for retirement
There are many on-line resources available to estimate your retirement savings accounts. The website calcxml.com has an on-line calculator that lets you put in some assumptions and lets you know how much you should be saving now in order to accomplish your retirement goal.
With your retirement goals and assumptions in place, it is possible to get a feel for how much money you need for retirement. I wish you the best in your financial self-reliant pursuits!
This article was written as part of the Financial Master Plan Antireliant Project my family is working on this month.
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