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Have you ever calculated how much money you will need to comfortably retire at age 65? The closest I ever got to knowing was the calculators the financial companies, where my 401K was housed, provided. I blindly accepted what the calculator came back with on whether I was on track or not.
Every person’s situation is unique and different, so it is worth everyone’s time to consider all the factors that play into having enough money for YOU to retire. The last thing you want is to come up short at 80 years old and have to find a way to make money.
This is the first article in a 4 part series. Each of the following simple steps will be reviewed in detail in the next 3 articles.
- Understand your current household expenses
- Estimate future monthly expenses
- Use 2 simple retirement guidelines to determine if you’re on track
Calculate Your Current Monthly Expenses
To understand how much money you will need in retirement, you must first understand where your money currently goes. Secondly, you must also understand how your current expenses will change when you retire.
If you track all your income and expenses you’re a step ahead of the game. For those who don’t track income and expenses, I recommend tracking at least your expenses for the next 3 months to get a good sense of how much you spend monthly.
Months like December, for those who celebrate Christmas, may be super skewed. It’s good to get an average over time.
The visibility of where you are potentially wasting money will be an added benefit to tracking your expenses for a few months.
You may pay subscription or memberships fees that you don’t utilize. The amount you spend on Ubers or taxis may surprise you and make you consider if that is where you really want your money going.
The amount of money you spend on extra-curriculars for your children who aren’t enjoying them or gaining a valuable skill set may be better put towards a 529 plan for their college years.
Little tweaks on your expenses can make a profound impact to how much you can save for retirement.
Determine Future Monthly Expenses
Your expenses in retirement will likely be different from what they are today. A few areas to consider are housing expenses, healthcare expenses and inflation.
Future Housing Expenses
Housing expenses will significantly drop if you are paying a mortgage on a home that will be fully paid off by the time you retire. There will still be home insurance and taxes to pay each year, so make sure to include those numbers in your expected expenses for retirement.
Future Healthcare Expenses
Healthcare is expected to be one of the largest expenses in retirement. My grandma broke her hip a couple years back and ended up in a nursing home for a couple months during recovery. Recently, she had a minor stroke and was in the hospital for several days. Neither of these events could have been anticipated but it’s almost a given that as you age the cost of healthcare will steadily rise.
According to Fidelity, “A 65-year old couple retiring in 2018 will need $280,000 to cover health care and medical expenses throughout retirement.” I have a long way to go before 65, so that number will be inevitably higher.
In fact, when Fidelity started estimating healthcare expenses for retired couples back in 2002, the amount was $160,000. That’s a $120,000 increase over 16 years.
The Effects of Inflation
The rise of inflation should also be considered when calculating the amount you will need in retirement.
What is inflation? Let’s assume, the cost of a picnic table today is $100. Next year, with a 2% increase in inflation, that same picnic table will cost you $102.
The rise in cost year over year of an item is inflation. The chart below gives you an idea of what inflation in the US has been over the past 20 years.
Since 1929, there’s only been a handful of inflation rates that went into the double digits, with 1946 being the highest. The inflation rate that year was 18.1% and 8.8% a year later in 1947, before dropping down to 3% in 1948.
Are you curious about what that $100 picnic table today would have cost in 1999? It was about $66. The average rate for inflation in the US is around 3%.
Decide If You Are on Track for Retirement
Once you figure out the amount you will need for retirement, the next step is to make sure you are on track to retire when the time comes. For many people that will likely be when they turn 65, but for others it could be earlier or later. Only you know what is best for you and your situation.
There are many retirement calculators available online that include the cost of inflation, but often they are not uniquely tailored to your expenses and lifestyle. These calculators can be useful guidelines, only if you properly understand your financial needs today and how they will differ in retirement.
2 Guidelines for Calculating Your Retirement Number
There are two general guidelines that can be used to simplify the process once you know your expected expenses in retirement.
The first rule, multiply by 25, says you should plan on having at least 25 times your expected expenses in retirement savings. Let’s say your expected yearly expenses are $50,000, then you will need to save roughly $1,250,000 for retirement.
The second rule, the 4% rule, then assumes a withdrawal rate of 4% each year. 4% of $1,250,000 is $50,000. The idea is that the money in your retirement accounts will continue to grow in retirement and even in the worst markets should hold you for 30 years of retirement.
Nothing is guaranteed though. Planning and flexibility will go a long way to making sure your nest egg isn’t depleted while you still need it.
There are a few important criteria to understand if you’ll be able to retire when you are ready:
- Your expected monthly expenses in retirement
- The amount you currently have saved
- The number of years you have left to save
- The amount you should save per year until retirement
- The rate of return on your investments.
It’s critical to understand if you are saving enough and adjust your savings rate accordingly. Could you imagine getting ready to retire and realizing you don’t have enough saved to retire? How dreadful!
In the next 3 articles, I will dig further into the 3 simple steps I listed at the beginning of this article. By the end of this series, everyone will have a clear idea how to determine if they are on track for retirement.
While retirement planning and saving may not be an easy mission, it certainly is a worthwhile endeavor. Get started by reviewing your current expenses.
Every few weeks, I will cover a new topic with the goal of saving money. Increasing your savings rate will undoubtedly help you reach your retirement goals faster and/or provide more money in retirement. Ironically enough, spending money to save time does not always equate to more time.
Thoughtful planning often leads to saving money and time. In future series, I will show you how to save money and time through developing a well thought out plan.
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