Planning Your Retirement

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.

FIGURE 1: NEW STYLE OR JUST UNDRESSED? Here's a representation of the value of your money in the not-so-distant future. If you're expecting to dress yourself in pretty much the same way in 2030 as you are in 2000, you may be in for a surprise.

Some factors you need to consider when determining your living expenses are:

When will you retire?

Is your standard of living going to be 100% of preretirement? More? Less?

How much money, if any, do you want to leave to your family or favorite charity?

Taking into account individual values and priorities, should anything else be included?

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.

FIGURE 2: SAVING. Here's a representation of the retirement capital of an individual who starts to save at age 25, assuming a $35,000 annual income, and the resulting value of his or her investment at three different rates.

Let's say that you turn 25 today (if that's the case, happy birthday!) and your salary is $35,000. Right now, you're planning to retire at 65 and expect to live to 90, but you're also considering earlier retirement if possible. With that in mind, how much should you invest for your retirement? You have the option of saving 7% every year with ease, 9% without too much thought, and 15% with a little effort. The choice you make can be the difference between enjoying your retirement and having to go back to work when you're 80. Something to think about.

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?

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PLANNING YOUR RETIREMENT INCOME USING EXCEL

SIDEBAR FIGURE 1: CALCULATION FOR YOUR RETIREMENT. You can calculate the value of your retirement account in Excel using the inflation rate, investment rate, and return on investment rate, using as an example a 25-year-old with a $35,000 salary.

You can calculate the value of your retirement account in Excel using the inflation rate, investment rate, and return on investment rate (sidebar Figure 1). Using as an example a 25-year-old with a $35,000 salary, the following variables were used:

Inflation rate of 3% annually -- This has been the average inflation rate for the last decade.

Investment rate: 9% annually -- This is the portion of the equation that you have direct control over.

Return on investment rate: 9% annually -- Depending on types of investments, this value may increase or decrease.

And these assumptions were made:

Cost of living increases proportionally with inflation.

Inflation, investment, and return rates stay constant every year.

Of course, you can adjust any of these to fit your ideal analysis.

EQUATIONS FOR EXCEL

Retirement investment (before retirement):

((Your salary for that year) * (investment rate)) + ((last year's investment) * (1+return on investment rate))

Example (at age 26):
($36,050 * 0.09) + ($3,150 * 1.09)

Retirement investment (after retirement):

((Last year's investment) * (1 + return on investment rate)) + (withdrawals for cost of living after retirement)

Example (at age 65):
($1,477,738 * 1.09) + (-$114,171)

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:

(Last year's cost of living) * (1 + inflation rate)

Example (at age 26): ($25,000 * 1.03)

Salary increases (before retirement):

(Last year's salary) * (1 + inflation rate)

Example (at age 26): ($35,000 * 1.03)

Salary increases (after retirement):

((Last year's salary) * (1 + inflation rate)) * (-1)

Example (at age 65): ($110,846 * 1.03) * (-1)

In this example, after retirement, you have to pay yourself from your retirement investment (shown as negative salary).