Quite often, I’ve been asked by my relatives how I have such confidence in my esitmation of what I’ll need to retire. I told them that I have developed a very specific process for developing an estimate of the amount of money I’ll need to retire. Please note that I am not including any pension or Social Security in my estimate because I don’t believe that this money will come to me when I retire in the future. If you wish to use those numbers to bolster your calculations, feel free.
Let’s meet our straw man, Gene. Gene is 28 years old and currently makes $54,000 a year. He wants to retire when he’s 57.
First, Gene uses the life expectancy calculator at MoneyCentral to determine that he is likely to live until he is 74, assuming no lifestyle changes. In order to give himself some leeway, he adds five years to this estimated age to give an approximate “end of life” age of 79.
Next, Gene calculates the number of years he’ll be retired. Since he estimates his end of life at age 79 and he wishes to retire at age 57, he subtracts the higher from the lower to estimate he’ll have 22 years of retirement. Not bad.
Now, Gene estimates what his salary will be when he retires. He figures that he’ll get about 4% a year in inflation raises and about 2% a year on average in normal raises, so he estimates his salary will go up about 6% a year. When he’s 57, his salary will be $270,919. Not bad at all, but that’s an amount that’s in “future dollars,” so it’s not as big as it seems.
Since his children will be out of the house by then and he’ll have his home paid for, Gene estimates he’ll only need 85% of that salary to live in retirement. So, Gene figures he’ll need $230,000 a year in retirement (approximately).
For the final calculation, Gene multiplies this annual amount by the number of years he estimates he will live to get the amount he needs to retire: $5,066,000. That’s a lot of money, isn’t it?
How can Gene possibly get there? Remember, Gene is only 28 – he has 29 years to reach his goal. If he saves 25% of his income each year for retirement (this would include an employer match, so it could be 20% or less that he actually heeds to save himself), and that investment can average a 12% return (pretty heady, but if he takes some big risks early, he might be able to get that), he can reach that number when he’s 57.
If you alter the numbers just a bit and allow for retirement at 62, he’ll need just $3,910,000 to retire. By only putting away 11% of his salary (6% put away with 5% employer matching does the trick), he will have that magic number. Is it worth it for those five glorious years of earlier retirement? It’s Gene’s call, but now he has the method to figure out things for himself.