The majority of workers go through their entire career with only a vague notion if they’re on track to retire. Nagging questions persist such as: When can I retire? How much do I need to save as a nest egg? What rate of return is appropriate for my investments? Most people have no idea where to begin and how to get answers to these questions.
Here is a good way to start; simply gather some basic financial information and do a few easy calculations. We call this the “arithmetic” of retirement planning.
First, start with your desired spending in retirement. If you have no idea, take a look at your current spending habits. If you keep good records in Quicken or Mint.com, you already have a good idea of your spending. If you don’t keep good records, start with your current paystub. If the net pay is $3,333 and you are paid twice a month, your overall net pay for the year is $80,000 ($3,333 times 24 pay periods for the year). Are you saving some of that $80,000? Let’s say you are saving $5,000 per year. So your current spending is approximately $75,000 ($80,000 less $5,000). Many will want to maintain their same lifestyle in retirement. However, you may want to spend more or less depending upon your goals. Let’s say you want to spend $75,000 per year in retirement.
Second, look at your fixed income sources such as social security and pensions. You can get your estimated benefits from the Social Security Administration on their website (www.socialsecurity.gov/mystatement). If you are fortunate enough to have a pension plan, check with your plan administrator. Let say you have $20,000 of annual social security benefits and a $15,000 annual pension income, which means your total fixed income is $35,000.
Now, subtract your fixed income from your desired spending amount. In our example, $35,000 of fixed income is subtracted from $75,000 of desired spending. The resulting $40,000 is your retirement shortfall. Don’t panic; most of us have shortfalls! This is why we have diligently saved in our IRAs, 401Ks and trust accounts. You can now determine approximately how much nest egg is needed to fund your retirement. Simply take your shortfall of $40,000 and multiply it by 25. The resulting amount is one million dollars. This is the approximate amount of nest egg required to fund your spending throughout retirement. Of course there are many variables that could change your required nest egg. You must consider inflation, income taxes, longevity, your investment rate of return, changes in spending habits, emergencies – you get the idea. But at least you know you need about one million dollars to retire at your current level of spending.
In our example, if you already have one million dollars and you’re old enough to collect your social security and pension income, then congratulations are in order – you can retire today! If you feel like you’re way off track (you’re not alone), take action as soon as possible. Perhaps you could cut your spending, save a little more each month, be more disciplined with your investment strategy, work longer, work part-time in retirement, downsize your home, retire to a cheaper area, etc. The worst mistake you can make is to procrastinate and assume the problem will magically disappear. Whether you’re on track for retirement or need to make adjustments in your financial life, it’s always better to know where you stand. Performing this simple calculation is a step in the right direction.