Sure, you’ve heard that you need just $1 million to retire comfortably. That may be the case for many people, however, that’s a very generalized number. It doesn’t take into account your personal situation or the kind of life you want to live while in retirement. This post will try to teach and examine what you need in retirement. While I try to be as close with my numbers as possible to the average norm, they will vary based on whom you ask. Consult your financial advisor if you have any more in depth questions. This is just a simple guide to figuring out what you need.
First, lets make the assumptions:
- You’ll live on 80% of your pre-retirement gross-income. This is a good number that is recommended by a majority of planners. Here’s the reasoning – when you retire, job related expenses decrease (food, clothing, fuel, etc). Some expenses can rise, like travelling but if you average it out, you don’t travel much when you’re 80 years old.
- The family will make $100,000 per year combined, they are aged 30 and wish to retire at age 65. Just makin’ it easy on myself here.
- Inflation will be 3% and you expect to get an average return of 10% from your pre-retirement investments and 7% from your post-retirement investments (I know, after re-allocation closer to retirement your return decreases).
- You both expect to live to age 90 – it’s good to be conservative to avoid running out of money.
Let’s figure this out, I always hated these problems in my college courses. In order to figure this out, we need to use the time value of money formulas. Read up on that wikipedia article if you don’t understand what it is. I’ll use excel for the calculations, you can use a regular calculator, but why make it hard?
First step – find the present value of your retirement needs from age 65 to 90 (25 years).
PV = ?
FV = $0 (we want to spend it to 0, if you want to save money for an inheritance, it’ll cost you more)
N = 300 (That’s 25 years times 12 payments per year, we want monthly payments, not annual).
i = .33% (7% minus 3% inflation divided by 12)
PMT = -$6,666.67 (80% of $100,000 divided by 12)
Put all that in your nifty excel spreadsheet or calculator and you get a PV at age 65 of $1,267,226.61. What does that mean? It means that the $1 million generalization is pretty close for these people.
No, how much do they need to save per month (assuming they have $0 saved right now) from age 30 to 65 (35 years)?
PV = $0 (they have nothing saved right now)
FV = $1,267,226.61 (use what you found in the first part)
N = 420 (35 years times 12 months per year)
i = .5833% (10% minus 3% inflation divided by 12)
PMT = ?
Put that in your excel sheets or calculator and you get a monthly payment of $703.60 per month. A reasonable amount if you can budget properly.
So you might be wondering to yourself, “well I guess the $1 million generalization is a good one.” Let’s see what happens if our family wants to retire at age 60 and then age 55 (I’ll spare you all the numbers).
The present value of retirement assets needed at age 60 is now $1,401,062.96 and the payments per month needed is $1,038.74.
The present value of retirement assets needed at age 55 is now $1,510,675.35 and the payments per month needed is $1,564.34.
So if you take everything into consideration, people with different goals and spending requirements do not always meet the $1 million generalization. Another interesting side note is that moving retirement from age 65 to 60 only requires about $300 more per month in savings while moving it from age 60 to 55 requires about $500 per month extra. This is why compounding is your friend and you should start saving early. Had we made their current ages 25, what would happen to their monthly payments?