If you are a recent college graduate you have an amazing opportunity. If you are willing to take a few simple steps now, you’ll have a much easier time preparing for retirement than people 10 years senior and older. Right now, you may not make as much money as people who have been at it for a decade or longer. But you don’t need to save nearly as much as they do – if you get to it. Let’s dive in.
Your Retirement Needs
When people start thinking about retirement, their first inclination is to get busy accumulating wealth. Saving and investing is important – I agree. But that’s not your first step friend.
Before you can know how much money you’ll need to save you first have to get a handle on how much money you are going to spend during retirement.
I admit that it’s impossible to know exactly how much money you’ll spend during retirement. For one thing, you don’t know what life will cost 20, 30 or 40 years down the road. And for another, you don’t know how long you are going to live. These variables make it impossible to predict your retirement costs with 100% certainty. I get it. But that doesn’t mean you are at a dead-end.
Figure out what you spend on average now and make adjustments for the future. If you spend $4,000 on average now for example, your costs might be lower when you retire; you might have your house paid off by then and you’ll probably have fewer dependents to carry.
Even if you have to guess, try to create a budget to reflect what your life might look like once you call it a day at work. Then, use an online calculator to inflate your figures to estimate what those future costs are more likely to be.
Let’s consider an example. If I spend $6,000 a month now, on average, I might only spend $4500 a month 10 years from now when I retire because my housing and support costs will decline. I take this information and input the data in an online calculator. Specifically, I take that $4500 number, plug in 3% inflation (that’s the 20-year average inflation rate) and determine that I will need $6048 a month when I retire in 10 years. This is the first step to figuring out how much we’ll need to save in order to retire.
How Long Will You Be Retired
Your next step is to determine how long you’ll need that money for. Let’s assume that you are going to retire at age 66. According to the Social Security Administration, a 66 year old male will live another 17 years (19 if you are female). Let’s say you work out, don’t smoke and take it easy on the Twinkies. So we’ll tack on another 5 years just to be conservative Now we figure that we need to have enough money to last about 23 years once we retire. We’re making real progress.
Determine The Shortfall
We know that we will need $6048 a month for 23 years. Now, let’s consider retirement income sources. Will you have rental or pension income? If so, add it in. At the very least you’ll have Social Security (yes….it will really be there) so we will consider that too.
For our example, let’s say you are only going to have Social Security and it’s going to be $2,000 a month on the day you retire. That being the case you need another $4,000 and change each month to bridge your income/spending gap.
Now we turn to another calculator to determine how much we will need on the day we retire in order to generate that $4000 a month – or $48,000 annually. To do that, we use a present value calculator. We input our numbers and we determine that we need $789,000 on the day we retire in order to generate $48,000 each year for 23 years. This assumes we’ll earn 3% more than inflation. By using the 3% rate – we can inflate our yearly withdrawal each year too which is important.
How Much Do We Need To Save Each Month?
The final question is how do we accumulate that $789,000? To answer that we’ll turn to yet another calculator.
If you are 26 now, figure you’ve got 40 years to invest. And if you can earn 5%, plug those numbers in and you see that you only need to save $537 a month in order to achieve your goal assuming you start with no savings at all. Obviously, if you have something put aside already, you won’t need to save quite as much each month.
Keep in mind that if you wait 10 years to get started you need to sock away almost twice as much. That’s why the earlier you get started the easier it is to achieve your goals.
This is a simplified approach to doing a little financial planning on your own. There are a few complications that I’ve ignored in order to show you in a general way what you are looking at. But you can easily compensate for the oversimplification by adding another 30% to your monthly savings amount. That may not be as exact as running a real financial plan but it’s an excellent start.
Figuring out how much money you’ll need to retire isn’t rocket science. Running this process may be a little outside your comfort zone but it’s a very worthwhile exercise. Take your time. Ask a nerd friend to come over and help you run your numbers. And most important, start preparing for your future by setting up your savings plan ASAP.
Do you know how much you need to retire? Are you setting aside money each month according to your plan? How does it feel?