Funding Your Retirement

You are probably looking forward to your retirement, especially the opportunity to leave behind the stresses of the daily grind that is a typical workday. To have a truly stress-free retirement, however, you will need to ensure you have the financial resources to adequately meet your needs during this phase of your life. When I say adequate in this context, I really mean having enough income to cover your expenses for the rest of your life. Just thinking about it might seem stressful but it does not have to be. Let us look at what you can do to make your retirement financially secure.

Estimate Your Retirement Expenses

In quantifying how much you are likely to spend in retirement you will have to consider the type of lifestyle you would like to have and the costs associated with that. Start with the basic expenses such as food, transportation, housing (rent if you don’t own your home, maintenance costs if you do) and of course, health care. You will have to consider the fact that as we get older, our expenses for doctors’ visits and medication go up and represent a larger share of our spending. You also must add discretionary spending based on your desired lifestyle, including travel and entertainment expenses. Once you come up with a number, you must then increase that to reflect the fact that prices rise every year. If we assume an annual inflation rate of 4%, then you should multiply your expenses at today’s prices by a factor of 1.22 if you retire in 5 years, 1.5 for 10 years, 1.8 for 15 years and 2.2 for 20 years. For example, monthly expenses of $8,000 today would increase to $12,000 in 10 years.

Identify Sources of Retirement Income

You then need to evaluate your sources of income when your monthly paycheck ends. This could include NIS retirement benefit, pension payments, Senior Citizens Pension (if your monthly income does not exceed $5,500), annuity payments as well as any other income such as rent from any property you may own. You can view NIS retirement benefits on the National Insurance Board’s website. Also, if your employer has a defined benefit plan you can estimate your monthly pension using the formula in the pension plan documents. Pensions for defined benefit plans are usually calculated as a factor x # of years’ service x final salary. With respect to defined contribution plans and deferred annuities, the monthly payment amount would depend on the value of the fund and the rate built in by the provider. You can use one of the annuity payment calculators available online to estimate the monthly income from a given fund amount, or ask your agent to provide.

Estimate Retirement Fund Required

If your projected monthly retirement expenses exceed your expected monthly retirement income, then you will need a retirement fund to provide additional income to cover the shortfall. Having identified the amount of the shortfall, you can then calculate the amount of savings you will require upon retirement to fill the gap. Such an amount will depend on the rate of return generated on those funds, as well as on your life expectancy. While this varies by individual and can be difficult to accurately quantify, as a rough rule of thumb, you can use a ballpark amount equal to the annual income required multiplied by 25. For example, if your retirement fund needs to provide a monthly income of $5,000, then the size of the retirement fund for someone aged 65 would need to be approximately $5,000 x 12 x 25 = $1,500,000. This amount, based on historical rates of inflation and investment returns in the US, and assuming 4% of the fund is withdrawn annually, would be sufficient to fund payments for over 30 years.

Savings Required

The next step in the process is to determine how much you would need to save on a monthly basis to reach your target retirement fund amount. In addition to the target amount, the rate of return on investments and the amount of time you have would dictate the level of savings required. There are numerous retirement calculators available on the internet that you can use for this calculation. As an example, someone who is currently 40 years old and wishes to have $1,500,000 at age 65 would need to save $2,218 per month assuming a return on investment of 6% per annum. An individual aged 30, on the other hand, with the same target amount would only need to save $1,092 per month which emphasises the need to start early and the big difference it makes to achieving your financial goals. You can also vary the return assumption to see how that impacts the monthly savings required.

Conclusion

The process I have outlined in this post should be done iteratively rather than sequentially. When you increase your retirement expenses your required savings will be higher, so you keep adjusting each, up or down, until you get to the point where you are comfortable with both your target monthly saving and your monthly retirement spend. Of course, this plan is not cast in concrete but should be revisited and adjusted as circumstances dictate.

You will see from running various scenarios with the retirement calculator that the investment rate of return has a major impact on the amount you will need to save to build your target retirement fund or, on the size of fund you will eventually have based the amount you can save. Such a return would depend on how your savings are invested. Dealing with that challenge will be the focus of our next post.

 

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