How to create a retirement plan.
Primary question will be "what is your picture of retirement".
Could be "stop living at work and start working at living".
Could be stop doing what pays the bills and start doing what stimulates the brain
Could be to travel the world
Could be combinations of above or things not mentioned.
For this discussion, I will assume you will spend a similar amount of money in retirement as you do while working.
I will assume a person makes $55,000 for this discussion
Objective #1. Determine how much you need.
ex A: If you want to retire early, take your current income and divide by .03. $55,000/.03=$1.84 M. Once you reach $1.84 M in this case, you can retire early.
ex B: If you want to retire in your 60's (closer to standard retirement age), take current income and divide by .04. 55,000/.04=$1.375 M (about 500k less than above).
ex C: If you choose to retire late (past age 70), take current income and divide by .05. $55,000/.05=$1.1 M. 700k less than early retirement.
The point is you can save yourself money by working later in life.
The .03, .04 and .05 is "withdraw rate", which will be discussed later. This % is defined as the % of nest egg you withdraw the first year of retirement. The lower the %, the more conservative the retirement plan.
Objective 2, learn to adjust "what you need". If you can "live on less" in retirement, you can make more assumptions. Live on less because you have a paid off mortgage, you moved to a condo for lower bills, you retired early, but chose a second job to pass time away... these factors allow you to reduce the 55k (used in example above). A traditional assumption is a person can live on 80% of their income in retirement.
so the calculations above:
55000*80%/.03=$1.47M (saved 400k)
55000*80%/.04=$1.1 M (saved 200k)
55000*80%/.05= $880,000 (saved 300k)
Issue 2- saving enough for the "retirement plan".
This depends on current age, retirement age, % of income you save, and how aggressive you invest.
3 examples (all with people either making 55k, or thinking they will be making 55k the year they retire). All examples assume a 10% annual return.
ex 1: A High School student (age 16) making 10k. saves 5% of his earned income in a Roth IRA. Assume this person skips college and works the day they graduate.
5% of 10k=$500.
At age 72, this person has the 1.1 M needed to replace 100% of a 55k income. They saved only $28,500, and have a total savings of $1.1 M
At age 69, the person in this example has enough to replace 80% of 55k.
If you add Social security into this situation, this person could retire in their 60's with their savings replacing 50-60% of income, and SS supplementing the rest.
ex 2: A college graduate which does not start saving until age 25. Make 40k coming out of college. Saves 10% of income (10% of 40k=$4000).
Somewhere between aged 64/65 this person will have enough saved for the early retirement option ($1.8 M).
This person contributed $164,000 to their retirement fund.
ex 3: a couple which did not start saving until their 40's. They make 68k, but have decided they can retire spending only 55k per year (55k is 80% of 68k). They save 20% for retirement once debts are paid off at age 45. 20% of 68k=$13750/year.
Between aged 68 and 69, this family would have saved their goal. ($1.3 M).
They saved $343,000 to reach this goal.
ex 1: set aside 28500 to have $1.1 M
ex 2 set aside $164,000 to have $1.8 M
ex 3 set aside $343,000 to have $1.3 M
ex 1 return (1.1M/28,500)=38X return
ex 2 return (1.8M/164000)=10X return
ex 3 return (1.3M/343000)=3X return
The time one's money was put to work is the biggest factor to achieving goals (this is "the power of compounding"). Time can be overcome with a higher savings rate, or resetting goals "lower" for retirement.
Creating a retirement plan before retiring
March 7th, 2007 at 06:33 am
March 7th, 2007 at 06:48 am
March 7th, 2007 at 08:04 am
I, for one, more concerned with quality of life throughout my lifetime than with having more money later on. There is a difference between having "enough" and having "more"
And I do not think that I will need to replace my income when I retire.
Here are few thoughts: You won't have commuting costs(currently for us 1,600 a month -- and thats with no car payment), you won't need to ... save for retirement.
We plan to retire in one of the beautiful countries in Latin America or Asia or Eastern Europe. We travelled everywhere, and love many placed (however, there is no way of telling how which place will change in 30 years. one can't even always predict what will happen in 5) But right now, there are many beautiful places on this globe where you can live nicely on 1000$ a month. (of course, it is wise to have a large buffer for unexpected medical costs, travel, etc...)
Right now we are saving 15% of our income each. Because we can meet that goal and the other goals we have. But in 3 years we intend to take another year off to travel -- some things are better enjoyed when you are young. (and not save for retirement during that year) We are fine with that.
March 7th, 2007 at 08:24 am
80% has long been used as the rule of thumb for calculating expenses in retirement, as it assumes that most people would find it desirable to have paid the mortgage off by then, but in my opinion, the huge monkeywrench called "healthcare costs" erases all other gains from otherwise lower expenses in retirement.
March 7th, 2007 at 08:38 am
Brooklyn girl is right, this is different for everyone (I save close to 16% right now) and it is important to live life while saving.
Fern- Nothing you or I can "do" about increasing health care costs... that is what medicaid/medicare are for (to prevent seniors from going bankrupt based on medical costs).
Maybe long term care insurance, which is another leg based on my blog from a few days ago is the solution..
The plan above did talk about "withdraw" rates, and one reason to replace 100% of income is because what one spends on a mortgage while young could be transferred to healthcare costs while older.
Another way could be using an HSA in addition to or instead of a IRA/401k. But those are detailed pieces. The point of this was to get someone started, not build a comprehensive financial plan in one post.
The discussion of savings rates (10%, 16%, 17%) is not that important, the important issue is the TIME one can let compounding work for them. All other factors being equal (health, annual returns, savings rates), the person with more time has more flexibility. Time can even trump a higher savings rate, a higher rate of return or many other issues. That was the point of the examples- give yourself TIME to allow savings to grow.
March 7th, 2007 at 11:26 am
What the poltiicians giveth one day they can take away the next. Count on nothing.
March 7th, 2007 at 12:34 pm
http://money.cnn.com/2007/03/05/pf/expert/expert.moneymag.mo...
March 7th, 2007 at 12:35 pm
Medicaid/Medicare will be reformed, they will not go away (too many people depend on them).
March 8th, 2007 at 06:40 am
I hope you're right about Medicaid/Medicare, but i wouldn't count on it. Didn't they just take the current SS surplus and use the money for the Iraq war? That money was not theirs to re-allocate, they're spending our retirement money!! So do you REALLY trust politicians to take good care of your Medicaid program??
March 8th, 2007 at 08:35 am
Benefits might get reduced or taxes inceased, but programs will not go away.
Reform is needed, but even reform will be to existing programs, I don't think it will create new programs.