I was thinking about retiring and realized that I had more questions than answers. I would bet many of you also had questions such as “How much do I need for retirement?” and “What steps should I take in order to have a smooth transition to retirement?”
Accordingly, I will be doing a three part series to answer these questions. I think that all of you will find these posts very beneficial for not only you but for friends and loved ones that you know.
I want to note that the outset that some people falsely believe that their income needs at retirement will decline since there are no kids involved, no college educations, usually no mortgage debt etc. However, this assumes that you only live in a rocking chair during your life. Retirees like to travel, have hobbies, help their kids and grand kids out etc. Moreover, medical and dental expenses rise as you get older. Trust me on this, your income needs will not substantially decline. They will simply change.
Part I: How much do I need??
Studies have shown that less than 4% can retire with the same standard of living at age 66 than they had before retirement. Many have to either continue working (think about the 82 year old guy who becomes a security guard), reduce their standard of living or move in with relatives to cut their costs. We need to change this dynamic ,which is what this series of posts will attempt to do.
So the first question is how much do I need? The answer depends on how much cash you want each year and whether you get a pension. Generally, experts recommend that you earn about 80% of your pre-retirement income. Thus, if you were earning $80,000 per year, you want a retirement earnings of at least $64,000. If you were earning $100,000 per year (before taxes), you should have an income of at least $80,000.
Now if you get a pension that covers this, great. However, I would bet most of you don’t get that much of a pension, and if you do, it won’t be enough. While we might get Social Security, it generally won’t be enough to cover this.
Thus, step one is to figure out how much 80% of your pre-retirement income is. Once you do this, you subtract any pension and Social Security that will have. Thus, if your pre-retirement income is $100,000, you want at least $80,000 a year in retirement plus a buffer for cost of living. Let’s assume that you get no pension and that your Social Security is $27,000 per year. (Note: Social Security can be as high as $3,500 per month for each worker who waits till age 70 or much lower if they take their benefit at age 62).
In our example, if we need $80,000, we subtract the expected $27,000 from Social Security giving us a need of $53,000 per year.
The next step is to divide the need (which in this example is $53,000) by -03. Experts recommend a capitalization factor of 4%. However, I think this is much too high of an earnings assumption especially if you want to have additional funds each year left over for additional investment for inflation. Thus, I have used 3% as a very conservative estimate in order to allow for an increase in your wealth due to inflation. Thus, $53,000/.03= $1,766,667 or more. This includes any savings or IRA or 401Ks too. If you have this amount, you are set. If not, you will need to read future posts about how to get to this level.
NOTE: all this assumes that you have NO DEBT including no mortgage. If you do have debt, the amount of your yearly debt service needs to be added to your pre-retirement income calculation. Also, if you have special income needs such as severely handicapped children who will need support for the rest of their lives, this support requirement has to be taken into account or you would need enough life insurance (divided by 3%) to equal the yearly support required for the child.
Part II, found here, continues looking at the steps you should be taking to prepare for retirement.
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