A look at retirement planning
Planning for retirement is a topic that may be daunting to many people. The objective of this discussion will be to make it less so. One could break the task down into three categories as follows. First, how much might one need each year while in retirement? Second, how many retirement years will need to be funded? Last, how can one accumulate the amount necessary to fund the expected years of retirement?
The first question is one of preparing a budget for each retirement year. One must determine monthly amounts for recurring expenditures such as shelter (either a mortgage payment or a monthly rental amount), utilities (electricity, gas, water, telephone, internet and/or cable service), medical care (Medicare and Medicare supplement costs, as well as expected copays and deductibles), food (include both meals in the home and/or restaurants), transportation (typically automobile costs such as a note payment, fuel, insurance, and repairs), entertainment (if you expect to take vacations they must be included in the budget) and finally a miscellaneous amount for a bit of built-in budgetary slack. Once this amount is determined it should be increased by an amount equal to the anticipated inflation to be experienced in the future. Assuming the recent past in an indicator of the future, a two-percent inflation factor might be warranted. This figure would then represent the amount of after tax funding that would be required each month. Then, the monthly figure is multiplied by twelve to arrive at the annual requirement.
The next issue requires one to face one’s own mortality. That is, how long can one reasonably be expected to live after one retires? A review of the mortality tables (2008 data) from the Statistical Abstract of the United States indicates the following. If one retires at age 60 and one is a white male, average life expectancy is 81 years. If one is a black male, your average life expectancy is 78.7 years. A white female retiring at age 60 has an average life expectancy of 84 years. A black female has an average life expectancy of 82.7 years. If one retires at age 70, the expectancies increase somewhat. The average life expectancies are 83.7 years for a white male, 82.6 years for a black male, 86 years for a white female, and 85.4 years for a black female. However, these are averages, so the next question might be how likely is it that one would live a longer than average life? A review of Social Security data (2007 data) provides information on this issue. If one is 65 years old and a male, there is a 40% chance that one would live
until the age of 85, and a 20% chance of living until the age of 90. If one is 65 years old and a female there is a 53% chance of living until age 85 and a 31% chance of living until age 90. For heterosexual couples aged 65 years, the joint probability of at least one partner living until age 85 is 72% and there is a 45% chance of at least one partner living until age 90. It would seem from this data that approximately 20 to 25 years would be a reasonable estimate of the retirement period.
The last issue is one that requires two calculations. First, a calculation to determine how much of a retirement fund to amass must be done. Then a second calculation, to determine the annual contribution to be made during one’s working career to accumulate the required amount at retirement. Let’s assume that the annual budget calculations from above indicated a requirement in retirement to be funded of $6,500 each month or $78,000 each year (It is assumed that this is the remaining amount after other sources of income in retirement, such as Social Security have been considered). Further, we will assume retirement at age 67, a 20 year retirement period, and an annual interest rate on the fund balance of 10%. Doing the proper present value calculation, a fund balance of $664,058 must be accumulated at age 67 so that the first of twenty annual withdrawals of $78,000 may take place beginning one year later. This, of course, is a large sum and at first glance would seem to be a difficult task to accomplish. However, if one starts early it is attainable. If one began investing for one’s retirement at age 27, an annual investment of about $1,500 each year (again assuming a 10% annual return) would allow the goal to be reached. Waiting until age 37 increases the annual investment requirement to about $4,037 each year. If one waits until age 47, the annual investment requirement goes up to $11,594. If one waits until age 57 the annual investment rises to $41,667.
The reader should take away from this discussion the following action points. First, a retirement plan (if one does not have one) should be made as soon as possible. It would be prudent to enlist the services of your financial advisor or accountant (particularly with regard to tax and estate planning issues beyond the scope of this discussion. Second, begin investing for retirement now.