Self-help guru Anthony Robbins once remarked that if several “experts” agreed on one area, you should probably mark it down as “the truth.” That’s why I’m always amazed when people begin talking about investments without discussing goals first. Every great financial planner I know starts with the goal and then works backward to determine what funds to use and how much to save. It’s a simple formula that’s actually pretty easy:
The Amount You Need to Retire = Amount You’ll Save x Rate of Return
Not complicated, was it? If you first figure out how much you need for retirement and the amount of risk you’re willing to take, then it’s easy to decide how much you need to save per paycheck toward the goal. OR if you have a set amount that you can save and know what you need, then finding your rate of return assumption is easy. This return will help you pick investments (you now only have to research a mix of investments that has a history of reaching that return).
How To Determine the Cost of Retirement
The amount of cash in your retirement bag-o-money depends on a few factors:
– longevity (how long are you gonna be around?)
– fixed costs, (such as a mortgage, health care, and utilities)
– discretionary costs, (including vacations and fun)
– inflation between now and then (many people use 3 or 4%)
– MINUS the amount you expect from sources such as pensions and Social Security
That’ll give you the amount you’ll need to retire.
Should You Plan On Working In Retirement?
I wouldn’t advocate planning on work in retirement. While I do think that a non-busy brain turns to mush (anyone know somebody who retired from a demanding job and then died months later?), counting on work income is a problem. Do you know if your health will hold out? Do you know that work will be available? There are so many variables that I liked planning on NOT working, and then if my client wanted to work that was extra “fun” money.
Want More? Here’s Some Fun
I love this video from The Makin’ Sense Babe, who’s given me permission to use her stuff here at Stacking Benjamins:
In Other News: Thanks to Edward Antrobus for linking to Jenny Lang’s guest post here a few weeks ago: A Job That Pays $800 Per Hour? Sign Me Up! His piece is on utility hacking and is an excellent resource if you’re planning on cutting your utility bill costs. Check it out!
Today’s Workout: 1 mile easy
Day’s I’ve Run In A Row: 345
Current Favorite Song on my “running” mix: Pompeii by Bastille
I always cringe when people say they are planning on working during retirement. There are so many “what ifs” there. Best to plan on not working, and save/pay off debt accordingly. Then, if you want to work and are able to work, go for it!
Amen, said the choir! I’m planning on working, but it’s not in my plan.
I haven’t calculated how much money I need for retirement or started saving. I’m finally in a place where I actually have extra money to save (which is awesome!) But, I my expenses are super, super low right now but won’t stay that way forever. I am really clueless as too how much money I’ll realistically need to retire.
What’s great is that coming up with the formula takes less than an hour and you’ll feel SO much better about picking (or deciding not to pick) investments because you did the legwork.
Mrs PoP @ PlantingOurPennies
Since we’re toying with the ideas of early retirement, we’re also considering where the money is coming from, which affects how much is locked up vs available without penalty and how it would be taxed.
Excellent point! It was always a headache dealing with SEPP rules for people who thought they should ONLY save into an IRA and then wanted to retire at 50. They made the job incredibly difficult on themselves.
I am lucky in that I have a pension, but I am still saving very aggressively in my 401k and IRA. I don’t plan on working in retirement, unless it was something I enjoyed doing anyway. I’d like to have a paid off house so I don’t have to worry too much about housing in retirement.
Sounds like you’re well on your way toward the goal. Did you calculate your retirement need?
Not exactly…I know that we’ll be fine with the pension and everything will just be extra (depending on whether we have a mortgage). I think the pension is pretty secure…but you never know nowadays so I should probably calculate my retirement need. Thanks for the idea.
I don’t think anyone should include working in retirement as part of their actual plan. That said, keeping that option in mind as an alternative isn’t a problem in my mind. Doing a part time job for some smaller side income might actually be enjoyable. Maybe blogging will still be around 30 years from now??
I totally agree with working during retirement. Frankly, I don’t see myself actually quitting work because it’s my hobby. Why would I quit?
That said, there’s a day that I’m projecting financial independence and that doesn’t include work. That way I can give the finger to “the man” (whoever that may be at the time) whenever I wish 😉
Matt @ momanddadmoney
Trying to make retirement planning too complex, especially when you have a long time before it comes, is incredibly counterproductive. There are too many variables when you’re talking about decades to do it with any kind of precision. Rough estimates are as good as it’s going to get. As long as you keep checking in to make sure you’re not too far off you can keep it very simple and find a lot of success.
I couldn’t disagree more. A pilot on the way to Hawaii doesn’t start off with a “rough estimate” of where the islands might be. Learn to do the work early and then (like the pilot) adjust your plan as things change.
If you’re saying that you don’t think a 25 year old should dig into their retirement numbers to decide how expenses will look, I totally agree…..but I also wouldn’t use a “here’s what I can afford” approach.
Matt @ momanddadmoney
“If you’re saying that you don’t think a 25 year old should dig into
their retirement numbers to decide how expenses will look, I totally
agree” Yes, that’s what I’m saying. I think you can use current expenses as a rough estimate but trying to get precise 20+ years ago is pretty useless. Too much will change between now and then. You can re-evaluate as you go and get a little better sense of what the numbers will actually look like and make adjustments as needed.
So I think you get a ballpark estimate of need, then determine how long you have to save, then determine the return you can expect, and the final result is how much you need to save. You can’t calculate your return based on how much you can save. It would be nice if it worked that way, but it doesn’t. If you’re facing a shortfall, you either have to save more, increase the amount of time you’re saving (which can be risky), or decrease expenses (also risky when projecting out that far). The best bet is to adjust your savings.
I have a number that I want to hit, but my plan is to have everything paid off and rental income coming in to cover expenses. That way we can tap as much of the retirement income as needed or take out the minimum when we get old enough.
I think I’ll always work doing something unless I’m senile and unable to control my functions. I saw a help wanted sign today at the amazing greenhouse/nursery down the road from my house. It’s like a sanctuary there. I almost applied, so I can see myself working somewhere like that when I’m old because it would be fun.
Yeah, I agree that no-one should plan to work in retirement. They may want to work until the day they die, but they should still not plan to work until the day they die from a financial perspective.
If you can plan your retirement so that at 65 you can live the life you wish with passive income, then if you wish to work you can and earn even more. But planning to have active income in retirement is a recipe for disaster!!
I loved the post. That said, the question that confounded me for the longest time were the next two: How much do I need (which The Makin’ Sense Babe touched one) and how much do I need to save each week/month/year to get there?
I typed out a big reply and ended up posting it to my blog instead and linked it here. Thank you for inspiring me. Love the setup. http://www.piratecents.com