When many of our clients are 5-10 years from retiring, they often ask us, “will I have enough money to live
on during retirement?” Here are the steps we recommend to help you determine if you have saved enough cash to live comfortably when you step out of the work world.
We discussed the first step of this process here. Now, let’s walk through the final steps in this calculation.
Step 2 – Calculate the nominal amount you will need to cover your expenses.
- Determine when you will retire. How many more years will you be working?
- Assume a standard rate of inflation. We recommend using 3% annual inflation.
- Take your expected current dollar needs found in #1 above and compound this number by your selected inflation rate for the number of years until retirement.
- (Multiply the net amount you calculated in Step 1 by 1 plus the inflation rate expressed as a decimal figure,
- Take that answer and multiply it by the same amount again for each of required number of years until you retire(e.g. 106.09 x 1.03 = 109.270; $109.27 x 1.03 = etc.)
Example – You need $100 in today’s dollars 5 years from now. Your chosen inflation rate is 3%. The table below shows how many dollars will equal today’s $100 dollars at 3% inflation after each year:
|Start||End of Yr. 1||End of Yr. 2||End of Yr. 3||End of Yr. 4||End of Yr.5|
|$ 100.00||$ 103.00||$ 106.09||$ 109.27||$ 112.55||$ 115.93|
This table tells us that in five years you will need a nominal amount of almost $116 for every $100 you spend today if the inflation rate runs at 3%.
Step 3 – Determine your Sources of income outside of your personal portfolio.
- Contact the Social Security Office and get an estimate of your social security payments at your expected retirement date.
- Contact any source of pension(s) to get an estimate of your pension at retirement.
- Note the amount of cash income you receive from any rental properties.
- Total your expected income for items 1-3.
Step 4 – Subtract your projected expenses at retirement from your Social Security, pension, and rental income at retirement.
- If your total is positive, you don’t need to worry – your income is greater than your expenses. Congratulations!
- If your total is negative, your portfolios – IRA’s, 401k plans, profit-sharing plans, and portfolios held outright – must produce.
- Add up your total investment portfolios. If you earned 3%, 4%, or 5% on today’s portfolios, would any of these incomes be enough to offset the shortfall of social security, pension, and rental property income and cover your expenses? If they are sufficient then, again you probably are okay.
- If your total is not sufficient to cover your expenses, you will need either to consider increasing your investment returns to such a rate that your portfolio (by your retirement date) will grow to a sufficient size to cover your expenses or plan to cut your expenses at retirement in such a way that the available income covers those expenses. Seeking higher returns implies taking greater risks: you will want to consult your investment advisor to determine whether obtaining such returns is feasible and most importantly can be done within your tolerance for risk!
Planning for your retirement future can be a daunting task, but if you follow these simple steps and plan accordingly, you can expect that your retirement years will be the most stress-free, relaxing, and fun years of your life.
If we can assist you with your retirement planning, please contact us at david at virginiaglobal.com or (757) 962-7976.