Last month I wrote about how your future income needs should play a major part in directing your saving and investing goals for retirement. This may make sense in concept, but what does it mean in actual numeric terms?
To illustrate the point, the following table provides an idea of how much money will be needed to fund various levels of annual income for 10, 20, and 30 years, based on various interest earning assumptions. The calculations in the table assume an inflation rate of 3 percent and that the annual income need increases at the same 3 percent rate each year.
Let’s look at the following example of 62-year-old Hal. It is determined that his annual income need upon retirement would be $84,000. Social Security and his pension will account for $32,000, and the remaining $52,000 must come from personal savings and investments. If Hal expects a 20- to 30-year retirement period (and assuming an investment return of 5 percent over that period), Hal will need a retirement fund of approximately $1 million to generate the additional $52,000 (see highlighted cells in yellow, above) and to fully cover his income needs later in life. Keep in mind that if his pension is not indexed for cost-of-living increases, he will need to save even more.
Thus, by calculating the sum of money needed to generate various annual incomes during retirement, you can assess whether an estimated income need is realistic or not. If, for example, it is determined that a certain projected capital base will be needed and you cannot realistically accumulate that amount, you may have to postpone retirement, continue working part-time, revise your income needs, or adjust your investment strategy to generate greater growth and earnings.
Unfortunately, many Americans are not prepared financially for retirement and do not have realistic views of the amount of funds that will be needed. According to a recent survey(1):
- 25 percent of workers think they will need to accumulate between $500,000 and $999,999 by the time they retire to live comfortably.
- 25 percent think they will need to save less than $250,000 for a comfortable retirement, while 19 percent feel they will need between $250,000 and $499,999.
- Workers who have performed a retirement needs calculation are more than twice as likely as those who have not to expect they will need to accumulate at least $1 million before retirement.
- Around 57 percent of workers who reported saving for retirement said they have less than $25,000 in total savings and investments (excluding the value of their home and defined benefit plans).
(1) 2015 Retirement Confidence Survey, Employee Benefit Research Institute and Mathew Greenwald & Associates.