Each one of us has a different notion of retirement. This implies that the amount of money you will need to retire can be too less or too much than others of your age. This is why you should come up with a personal estimate of how much you need to retire. Needs, wants and goals of retirement differ from person to person and so there is no one-size-fits-all solution.
You start by calculating how much you want to spend every month because if you want to spend more, you will have to save more. Your retirement age will also have an impact on how much you will need. Here are the four steps that help you determine how much you will need to retire.
Step 1: Calculate Expenses
The first step in determining how much you need to retire is estimating the retirement expenses. This is the amount you think you will spend annually in your retirement. The expenses include the estimated taxes you pay on retirement income. To get started, you can look at your current take-home income.
Assume that you spend the amount you take home each month and use it as the estimate of the monthly amount you will need in your retirement. You can consider the changes that will come in the retirement period and adjust your estimated expenses.
Step 2: Calculate Income
It is important to identify the amount of income you will get from guaranteed sources. These sources can include social security, pensions, monthly annuity payments and others. More the number of guaranteed sources you have, lesser you need to save.
Then, you compare this income to your estimated expense of retirement. At least half of the expenses should be covered by the guaranteed income by the age of 65. If not, you should consider an annuity that provides additional guaranteed income.
Step 3: Calculate the Difference Between Income and Expenses
The third step is calculating the gap between your expenses and sources of income. For example, if you have an annual retirement expense of $40,000 and a guaranteed income of $30,000, the gap is $10,000.
The gap represents the amount which you will need to get from your investments and savings every year. Adding up the gaps of each year over the expected retirement years gives you an estimate of how much you need to have saved to be prepared for the retirement.
Factors to Consider
Factors like income tax, property prices, life expectancy, return on investment, cost of living, inflation, bank loans, and your spending rate are likely to change and affect the amount you will need for retirement.
To account for such variables, it is necessary to develop a best and a worst-case scenario plan. While a best-case scenario considers average to high returns on investment, low inflation and average life expectancy, a worst-case scenario assumes above average life expectancy, low returns and high inflation.
If you find that your retirement plan works only in the best-case scenario, you should figure out something different. You might want to work more, save more and spend less to get a working plan.