How much will I need to retire?
Saturday, June 15, 2002
Part 4 of a 4-part series
With retirement looming just around the corner for a large segment of the population, and with the nightly news full of cautions about how few people will have enough set aside, a question increasingly cropping up at dinner parties is "How much do I need to retire on."
Although the answer depends largely on how well you want to live in retirement, how long you live, and how healthy you are while you're alive, you can use a widely-accepted methodology among financial professionals to get a ball-park idea of where you stand. You can also figure out how much you need to set aside monthly to make up any shortfall.
The methodology comes down to this:
|(1)||Estimate retirement income needs;|
|(2)||Estimate retirement income resources;|
|(3)||Subtract (2) from (1) to determine your Retirement Income Gap (RIG); and|
|(4)||Estimate savings necessary to bridge the RIG.|
Consider an example where current annual expenses are $72,000, but only 70 percent of that -- $50,400 -- is needed in retirement. With inflation at 3 percent and 10 years remaining until retirement, a $50,400 annual retirement income need today grows to $67,733 by retirement.
Assuming inflation continues at 3 percent post-retirement, that principal is liquidated, that investments earn 6 percent after-taxes, and that retirement income is needed for 20 years, the total capital needed to fund the retirement income need is $1,045,480.
The next step in the methodology is to determine retirement income resources.
Retirement income derives from three sources:
-- Private savings;
-- Employer-sponsored programs; and
-- Government-sponsored programs.
Tally up how much you have currently earmarked for retirement in savings accounts, certificates of deposit, life insurance cash values, annuities, money market funds, mutual funds, and individual stocks and bonds. How much have you contributed to IRAs and Roth IRAs?
Next, look at the annual benefit statement from your employer. The statement discloses your account balance in 401(k) and profit-sharing plans and informs you about how much you can expect to receive from defined-benefit pension plans.
Also, search your files for the statement you received from the Social Security Administration. The government now sends statements telling you how much to expect at ages 62 and 65.
Add your private savings and account balances from employer-sponsored plans together. Also, add up how much annual income you expect from pension plans and Social Security at retirement age.
To make an apples to apples comparison of retirement income needs to retirement income resources, you must project the value of assets earmarked for retirement to retirement age. Also, you need to discount Social Security and pension benefits to a capital amount at retirement.
Say, you had $50,000 in a 401(k) plan and $40,000 in mutual funds. Ignoring future contributions and assuming a hypothetical 6 percent after-tax return, these resources grow to $161,176 in 10 years. (This would be reduced by income tax on the portion of the $50,000 in the 401(k) plan that was not previously taxed.) This is referred to as the future or projected value of these assets.
Furthermore, if you expected $14,000 annually for 20 years from Social Security, $9,600 annually for 20 years from an employer pension, and assumed a discount rate at 6 percent after-taxes, these income streams are worth $270,690 at retirement. This is referred to as the discounted or capitalized value of these income streams.
Now, add the future value of your private savings and account balances from employer-sponsored plans to the capitalized value of your Social Security and pension benefits at retirement age. Together these amounts are your total retirement income sources.
For example, when the $161,176 projected value of 401(k) and mutual fund assets is added to the discounted value of Social Security and pension benefits--$270,690--total retirement income resources amount to $431,866.
Once you've calculated the capital value of your retirement income need and retirement income resources, it's a simple matter to determine the retirement income gap (RIG). The RIG is simply the difference between needs and resources.
At this point in the process, many people seek the help of a licensed financial professional to help you determine how much should be invested to bridge the retirement income gap.
Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )