Will My Money Last as Long as I Do?
Will My Money Last as Long as I Do? To calculate how much money you’ll need to support yourself during retirement, it’s important to understand your current budget. This is because you need to be able to project, using estimated inflation, how today’s expenses will correlate during retirement. Know how much you spend today Knowing how much you spend today can help you determine how much you’ll need during retirement. At Hopkins Investment Management, we recommend that our clients develop a budget and keep a record of all their expenses. One of the best ways to do this is to use a program like Quicken or Microsoft Money, or a service like the one provided at www.mint.com. I personally have used Quicken for 20 years. The value of a program like Quicken is that you can enter budgeted income and expenses at time intervals such as bi-weekly or monthly, based on personal preferences. Then Quicken can be linked to your various bank and credit card accounts, and all future transactions will be reflected in the program. You can set up various expense categories such as clothing, household expenses and groceries, and once everything is in place, you can begin to compare actual income and expenses vs. budgeted income and expenses. I have found that, by applying this process diligently through the years, I have been able to more accurately project future expenses. This process is vital in assessing or projecting you’re your expenses may be when you retire. How to project retirement expenses based on current expenses In preparing financial plans for my clients, I assume a 3% yearly inflation over their lifetime. I review my clients’ financial plans annually and, if long-term inflation rates appear to be rising, I make appropriate adjustments in my assumptions. To estimate your expenses during the first years of retirement, use your present budget and project total budgeted expenses by compounding them at 3% per year. A common rule of thumb states that your expenses will be reduced 20% during retirement, the reason being that there are certain expenses which will not continue during retirement, such as most of the deductions on your pay check. Further, because you will no longer be travelling to work each day, your daily travel expenses will be reduced, as will items like business clothing expenses. However, I recommend to my clients that they project their retirement expenses based on 100% of their current expenses. This is because there are expenses that will likely increase during retirement, such as vacation travel and medical expenses. Any current loans that will be paid off before retirement can be excluded. There is a useful “Compound Interest Calculator” at http://www.hopkinsim.com/resources/3 that can help estimate current expenses with compound interest. The following inputs are required: Current principal: The present total of your expenses per year Annual addition: Not applicable Years to grow: Number of years between now and date of retirement Interest rate: In this case, 3% per year Compound interest: “1” time annually Make additions: Not applicable, so “start” or “end” are fine So, how much income will I need during retirement? Knowing what your projected retirement expenses will be is a vital part of knowing how much income you will need during retirement. The minimum is an amount that will pay your projected retirement expenses as calculated above. You may then add a desired income buffer over and above projected expenses. Your next step is to determine anticipated sources of income and the extent of that income. Most likely sources of income are: 1. Social Security: The annual statement you receive from Social Security Administration provides estimated SS projections at various retirement ages. 2. Pension income: Your employer should be able to provide you with an estimate for your retirement age. 3. Investment income: Financial planners typically advise their clients to plan to withdraw 4-4.5% of their investment capital. Assume that your investments will grow more than 4.5% per year – your annual withdrawals should not reduce your investment capital throughout your retirement. To calculate how your investments will contribute to your retirement income, make a projection of the value of your total investments at retirement. Visit http://www.hopkinsim.com/resources/3 and use the following inputs: Current principal: Present total value of your investments Annual addition: Amount added annually to your investments Years to grow” Number of years between now and date of retirement Interest rate: Use a conservative projected return of 5% per year Compound interest: “1” time annually Make additions: At “end” of each compounding period When you know the projected value of your investments at retirement, calculate 4-4.5% of this total to withdraw for living expenses. Add this to the first two items above to get a total retirement income amount. Congratulations, you now have a good idea of your retirement expenses and the amount and sources of your income. It’s important to update these projections at least annually. While you may certainly be more than able to make all the above projections, I strongly recommend engaging the services of a Certified Financial Planner to assist you with regular updates. Certified Financial Planners are trained in a number of disciplines that impact the calculation of future financial needs by taking into account vital elements such as taxes, disability and long-term care insurance. Further, in engaging a Financial Planner, I recommend one who has the CFP® designation and is a fee-only investment advisor. A good place to search for such an advisor is www. napfa.org. Now that you are armed with this information, good luck and happy retirement! Even if your actual date for retirement is still a long, long way off. |