A former client once argued with me about his "retirement number." He couldn't believe that he needed $1 million in savings before he could retire. "That amount just seems like way more money than is necessary!" But after walking through the variables and calculations, he finally said, "Geez, a million bucks. ... I guess that's my number."
Just as taking the dreaded step onto the scale is a necessary part of the weight-loss process, so too is crunching the numbers for retirement planning. According to the Employee Benefit Research Institute (EBRI) 2011 Retirement Confidence Survey, only 42 percent of American workers have taken the time and effort to complete a retirement-needs calculation. Without going through that process, you're flying blind into your retirement.
Please know that this is not rocket science, especially in an age when there are so many online retirement calculators available. I like EBRI's Choose to Save Ballpark E$timate, which is easy to use, but your retirement plan/401(k) website probably has a tool available as well. The tricky part about using these calculators is that they ask you to estimate several factors that even economists can't agree upon - like the future inflation rate or expected rates of return on investments. My crystal ball isn't perfect, but here are some sensible estimates that should help:
-- Inflation assumption: 4.5 percent (higher than where we are today, but most economists believe that inflation is headed up in the coming years).
-- Rate of investment return both before and after retirement: Consider your risk tolerance and err on the side of being conservative. If you're stuck, use 4-5 percent. Obviously, if you use a higher rate of return, the calculator will ultimately determine that you have to save a smaller amount. After our Great Recession and financial crash, I probably don't have to tell you that higher return assumptions may not always work out as planned.
-- Life expectancy: If you are younger than 50, use 95; if you're older than 50, use 90. If you want a closer estimate, go to livingto100.com and use their Life Expectancy Calculator.
Many calculators will take a percentage of your pre-retirement earnings (most use 80 percent) as a baseline for what you will need in the future -- sometimes called a "replacement rate." A more precise way to determine that number is to figure out how much you spend today, isolate those expenses that won't occur in retirement (for example: mortgage payments, if you are on track to pay it off before retirement; tuition; child care; commuting expenses) and - poof - you have your replacement rate.
When I was a young financial planner, it was common practice to remove Social Security and Medicare taxes from your anticipated future need, but now I think it's probably best to assume that the money you were paying in FICA will be necessary to pay some or all of higher health care costs in the future, so leave that amount in for your calculation.
Then you will be asked to plug in the amount of money you have already saved, your annual contributions to your retirement plans and other investment accounts, any future pension amounts, and a Social Security benefit. While Social Security might change in the future, most of the revisions being contemplated would not affect people who are currently over 50. For those under 50, you might have to wait longer to collect benefits or the benefit amount could be reduced. To adjust for an altered Social Security landscape, you could simply raise your replacement rate by 5 percent.
Once you have entered in all of the information, the calculator is going to spit out your results. For many, this moment could be as stressful as stepping on the scale. But only when you are armed with the necessary information can you alter your course to a smooth retirement. So don't be afraid to take the plunge and discover your retirement number.
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