Estimating Retirement Savings Needs
Financial advisors frequently tell individuals to plan on between 70 percent to 80 percent of their annual pre-retirement income during retirement. These estimates are in line with the findings of the American Society of Pension Actuaries shown in Figure 1.
While Social Security and a company pension may provide some retirement income, these sources alone will rarely suffice. Most retirees find that they have to draw on their own savings and investments as a supplement.
FIGURE 1: RETIREMENT INCOME Compensation Replacement Ratio $42,000 77.3% $50,000 76.1% $60,000 75.1% $72,000 74.3% $86,000 73.6% $103,000 73.0% Source: NAtional Retirement Income Policy Research papers, June 1994
The Effects of Inflation
Over time, inflation can significantly erode buying power (Figure 2). Before retirement, employers may increase salaries to compensate for increases in the cost of living, Social Security benefits and some pensions are also periodically indexed to keep pace with inflation. However, increases in the income from savings and investments is not automatic. That makes it all the more important to save a sufficient amount and to invest savings wisely.
FIGURE 2: INFLATION FACTOR To use this table, find the number of years until retirement then estimate the future inflation factor (historically about 4 percent). Years Until Retirement Assumed Inflation 3% 4% 5% 5 1.16 1.22 1.28 10 1.34 1.48 1.63 15 1.56 1.80 2.0 20 1.81 2.19 2.65 25 2.09 2.67 3.39 30 2.43 3.24 4.32
How Much Income?
The Retirement Income Worksheet (Figure 3) can be used to estimate the annual amount of income from savings and investments needed for comfortable retirement. The calculations take into consideration the income from other sources and the effects of inflation.
The Social Security Administration will estimate the benefits of individuals who request a Personal Earnings and Benefit Estimate Statement. Employers should be able to help estimate company pension amounts.
The worksheet shows the annual retirement income which must come from savings and investments. The savings needed to produce a specific income are shown in Figure 4. Using the income figures and an investment return you might realistically expect to achieve after inflation and taxes, the additional savings to be accumulated before retirement is easily read. For the purposes of the worksheet example, the individual should need about $650,000 of additional savings to reach his or her income goal (at an assumed 3-percent after-tax, after-inflation return). …