Have you seen the TV commercial for Prudential where Professor Daniel Gilbert asks the question: “How much money do you think you’ll need when you retire?” There is a second commercial where Professor Gilbert uses ribbons to see how long your retirement funds can last. Of course, neither of these commercials provides an answer to the question.
In my Financial Decision Making course at National Louis University, we address the question of how much money you need upon retirement. It is interesting to note that I haven’t had a single student acknowledge that they have the answer to the question as we begin the course. The average age of our students is 38, adults returning to the classroom to complete their degrees. The students are anxious to learn the answer but never thought of its importance until they took the class.
The answer to this question varies, depending on the financial needs of each individual and what their expectations are for retirement. There are several steps to getting to the answer. A number of assumptions need to be made, concerning your individual situation:
Step 1 – Start with your current annual income and estimate what percentage of this amount you will need annually during retirement. Don’t forget to estimate funds for the additional fun things you plan to do in retirement.
Step 2 – Summarize your current retirement savings. You may have more than one source of these funds: e.g. 401K plans, pensions, etc.
Step 3 – Decide what age you wish to retire.
Step 4 – How long do you plan to be in retirement? According to the Social Security Administration, life expectancy for males is 84 years and for females is 86. So, if you are a male and retire at age 65, you would expect to be in retirement for 19 years.
Step 5 – What investment return do you expect to realize on your investments before and after retirement? According to Peter Dunn (author, radio host, and TV personality) on his website Practical Money Advice for Real People, he suggests that 7.81% is a reasonable expectation for current investments. However, he acknowledges that many of his colleagues use rates from 8% to 12%. Your rate of return depends on your investment portfolio.
Step 6 – Now take the answers to steps 1 through 5 and use the Retirement Calculator located at www.calcxml.com/calculators/retirement-calculator?skn=#top. You will be provided a detailed analysis, year by year, of your retirement funding. You can experiment with this calculator by changing some of the answers to the assumptions and re-run the analysis. The information provided by this analysis should allow you and your financial advisor to manage your retirement planning more effectively.
