|Whether you're gloating because your Presidential candidate won the election or ticked because he didn't, you still have to plan for your retirement. Unless you run for public office yourself, you really don't have control over your government-aided retirement income. It's common knowledge that Social Security is underfunded, and at its current rate may be nonexistent by the time you retire. With that in mind, the amount you need to save and how you do it are two questions you have to address right now. |
Given that no one can predict the future, you have to project what the cost of living will be by the time you retire. Take a look at the hypothetical cost of living in 2030. Assuming average inflation increases by 3% (which has been the average inflation rate for the last 10 years), a nice pair of slacks that costs $100 today will cost you about $240 in 2030. That means $100 in 2030 will leave you feeling a little drafty in the future (Figure 1). You will need to be making about two and a half times your current salary in 2030 just to have the same standard of living you do now. So thinking about your retirement in today's dollars will not take into account the costs of living adjusted for inflation; planning your finances need to go up to, and include, your retirement years.
Your life expectancy and the inflation rate are generally figured to be 90 years and 3%, respectively. If you like, you can change these estimates and make them higher or lower to determine a range of possible living expenses (see sidebar, "Planning your retirement income using Excel").
Let's look at a simplified example. Figure 2 represents the money you save and the amount of money you will have when you retire. There are two major assumptions in this calculation: first, your investment has a 9% return every year compounded annually, and second, inflation and your salary will increase at a rate of 3% annually. For simplicity's sake (as in, who knows what the government will do with taxation rates), tax is not considered.
Take a look at Figure 2. If you were to invest 7% of your salary until you retired at 65, you would have gathered about $1.15 million for your nest egg. You could continue to live at the same standard of living you were prior to your retirement, but due to the increase in the cost of living, your withdrawals from your retirement investment would have to slowly increase. At this pace, you would have spent all of your retirement investment by the time you turned 80. Do you want to go back to work at that age?
Making just a little adjustment to your investments can completely change that scenario. By investing 2% more each year (9% annually), the value of your nest egg at 65 is close to $1.5 million and peaks at about $1.63 million when you are 72. Instead of going back to work at 80, you can enjoy your golden years to their fullest extent and still have about $100,000 left over.
But if it's early retirement you're aiming for, then you'll have to invest a bit more. By investing 15% annually, you will be able to retire on your 59th birthday and still be a millionaire at 90.
As you can see in Figure 2, your money starts to increase exponentially in the later years of your working career. This is where you can make the most from compounding interest. The longer you wait to retire, the bigger your nest egg. Just investing a little more each year could make a huge difference for your golden years. So what's it going to be?
And these assumptions were made:
Of course, you can adjust any of these to fit your ideal analysis.
EQUATIONS FOR EXCEL
Retirement investment (before retirement):
Retirement investment (after retirement):
In this example, you are no longer adding to your retirement investment but withdrawing from it and still have a return on your investment.
Cost of living:
Salary increases (before retirement):
Salary increases (after retirement):
In this example, after retirement, you have to pay yourself from your retirement investment (shown as negative salary).
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