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Your retirement nest egg
Whether you are counting down the days to retirement, or just starting to plan, the whole concept can be pretty daunting. For most, it will be the first time in many years that they can’t depend on a regular paycheck for income. To cover the cost of living, the majority of retirees will need to tap into their assets and social security benefits. Unfortunately, it’s not as common to have a pension plan now, as it was in the past.
At some point, you may wonder how your savings will stack up. Questions might come to mind like "how long will my money last?" Or, "what kind of income can I expect to have?"
These are all valid questions. To prepare for retirement, you'll have to forecast your needs for many years (and decades) into the future.
While its impossible to predict precisely how long you’ll live, it’s always best to err on the side of caution. Given the fact that lifespan is continually increasing (read a paper on it here), it’s essential to plan for the long haul. The world as a whole has achieved impressive progress in health and life expectancy over the last 200 years. As such, it’s likely that you’ll want your savings to survive along with you.
To reduce the risk of depleting your savings prematurely, its wise to base your plan around the idea that you’ll live to the ripe age of 90 or 95. Couples should expect one spouse to live an extra few years too. For most, that means re quiring savings for 25 to 30 years. If longevity runs in your family, you may even want to consider saving a bit more.
How much should you save?
If you are new to the workforce, or mid-way to retirement, you’ll likely want to know if your rate of saving has you on the right track. Unfortunately, no official number is considered a benchmark for retirement savings. Household spending patterns can vary tremendously from one individual (or family) to another. A better way to estimate your needs in retirement is to consider how much of your current income you need to maintain your standard of living.
A recent study done by GOA found that most financial planners and retirement firms suggest replacing 70% to 85% of your annual pre-retirement income. As an example (using a 75% income replacement rate) a person making $100k should save up 75k for every year they plan to be in retirement. To guarantee 30 years of retirement income, he or she should aim to have about $2.8mil in the account (75k x 30 years x 1.25% for taxes).
However, this is a generalized figure and might not be accurate for everyone. In fact, most financial planners don’t use income replacement for their clients at all. You’ll have to consider your financial obligations and personal circumstances to figure out how much you’ll actually need.
That said, using an income replacement rate to gauge your savings could be helpful early on in your career (in your 20s, 30s, or 40s). Then, as you get closer to retirement, you should refine your calculations.
Keep in mind these key factors:
1. Not everyone that retires stops working altogether. Many retirees like to keep (or seek) part-time work for some security and enjoyment. You may even get the chance to something you love, even if it doesn’t pay as much as you’re used to.
2. Your spending will likely be lower in retirement, than during your peak working years. The study by GOA shows us that workers spend the most between the ages of 45 and 49 with their annual expenditures around $58,500. That figure drops by 46% for retirees over the age of 80.
3. The most significant expense for people is their home. Many retirees choose to downsize their house or pay off their mortgage when retiring, which can free up thousands of dollars that would otherwise go toward expenses.
4. The cost of healthcare tends to be higher for retirees, than younger workers. Depending on your family history and current health status, you’ll have to budget accordingly.
Other factors that can influence your income needs in retirement include your marital status if you have children,
With that in mind, you’ll have to define a yearly allowance so that you don't outlive your savings.
The 4% spending rule
Our calculator determines how long your savings will last based on your investment returns and expense patterns. But another way to estimate how your savings will fare over time is to apply the 4% rule.
By only spending 4% of your savings each year (and adjusting for inflation), your retirement savings can last for 30 years. However, like income replacement rates, the 4% rule is not perfect either. As with any other financial tool, it can give you some basic insight on how your savings will stack up.
For example, let’s say that you’re planning to save $1,000,000 by the time you retire. Using the 4% rule, you’ll be able to withdraw about $40,000 each year for the next 30 years. Then, you have to determine if that is a reasonable income to maintain your standard of living. If not, adjust your plan while you still can.
Using the calculator
The calculator is very straightforward to use. You’ll have to add some details about your savings and expenses to model how long your earnings will last. You can use the amount you think you’ll spend each year, or tally up your expenses. Let’s review the questionnaire together.
Step 1. On the first line of the calculator, input your retirement savings. You can add what you currently have saved or what you think you might need for a comfortable retirement. Use your keyboard or the arrow features to make this input easier.
Step 2. Next, add the amount you expect to spend each year while you are retired. If you think your spending might vary throughout your retirement, or are unsure, you can leave this blank and use the withdrawals later on in the questionnaire.
Step 3. On line three, state the rate of return you’ll be getting from your investments during retirement. It's important to allocate your assets differently in retirement, then during your peak working years. As an example, you may want to keep a small portion of your capital in large-cap stocks and move most of your investments to bonds or cash equivalents.
Step 4. Specify an expected rate of inflation on line four of the calculator.
Step 5. In the next two sections, you can document up to 10 withdrawals. We recommend using each row for differ expenses. For example, dedicate Row 1 to your annual housing costs, row 2 for your yearly travel expenses, and row 3 for recurring healthcare etc. You can specify when the withdrawals will start and end to get an accurate estimate of how long your savings will last.
Step 6. Once the questionnaire is completed, you can view your results in the form of smart summaries, graphs, and tables.