Saving for Retirement – 5 Steps in Planning for Retirement Income Needs

How much money to retire do you need? How much do you already have? How much time do you have to save? These are the questions that lead you to a retirement saving plan. A well-thought out and diligently followed plan leads you to your goal. This section walks you through the major steps in planning for your post-retirement financial needs.

Estimating Your Needs
The starting point is to estimate the income level you will need in retirement to live the lifestyle you have become accustomed to, taking into account changes retirement will bring. Start by working up a detailed budget for your current living expenses, then adjust each item based on how you think your retirement lifestyle will affect it—will it go up, remain the same, or go down? The following worksheet can be used to prepare a detailed post-retirement budget.

The Impact of Inflation
You now need to adjust your estimated post-retirement needs for inflation. Although you can’t know what future inflation will be, you can look at what it has been in the past and use your judgment to pick a rate for planning purposes. The highest 10-year period in U.S. history for inflation was 1973 through 1982. During this period, it averaged 8.3 percent per year. By 1986, it had dropped to 1.1 percent. The 1990s started off with a rate of 6.1 percent but ended with an average of 2.2 percent. From 2000 to 2003, it further dropped to an average of 1.6 percent and then began trending upward to 3.5 percent in 2005. From 1914, the overall average is 3.5 percent. Given this history, a rate from 3–5 percent seems reasonable for planning purposes.

Meeting Your Income Needs
In retirement, most people receive retirement income from three sources—employer pension plans, Social Security, and personal savings. In the following calculation, you estimate what you can expect from employer pensions and Social Security. This is compared to your estimated retirement income needs to determine what you must provide from personal savings.

The Social Security Administration sends an annual statement of earnings history and benefits estimate to every wage earner. You may also phone (800) SSA-1213 or visit the Social Security web site (www.ssa.gov) to request a customized benefits estimate. Also, your employer’s pension plan administrator will provide an estimate of your pension benefits.

The amount of personal savings you will need to fund your retirement depends on several variables including inflation, return on investments, and how long you will live. You already have an assumption about inflation. You should continue to use this number. You can expect investment returns to exceed inflation by 3–4 percent. You can be conservative and add 3 percent to your assumed inflation rate or be optimistic and add 4 percent. You can estimate your life expectancy from Table 3, which is based on the IRS life expectancy tables. A brief look at the table shows that for planning purposes, it is reasonable to plan to age 90 unless you have reason to adjust this number either up or down.

This calculation gives you an idea of the capital you must accumulate to fund your estimated retirement income needs. However, there is one more issue to consider. Most pensions are not indexed for inflation. Therefore, you need to calculate the additional capital required to maintain your pension’s purchasing power.

Adjusting for Early Retirement
If you plan to retire before you’re eligible for immediate Social Security benefits, you need to provide additional savings to help meet your retirement income needs until you qualify for Social Security. Typically, those retiring before age 62 find it to their advantage to begin drawing benefits at age 62, or the earliest age at which they qualify. For workers born before 1938, age-62 benefits are 80 percent of the age-65 full benefits. Workers born in 1938 and later qualify for full benefits at a later age.

What You Have Today
You probably have some savings already set aside. But, considering the years until you retire, inflation, and return on investments, do you have enough now and are you adding enough each year?

In this section, you inventory your retirement assets, project them to the year you plan to retire, compare the results to the total savings required at retirement, and calculate the additional amount you must save it for your retirement income needs each year.

Savings Required to Meet Your Goal
You now have the information necessary to determine your savings goal between now and retirement. This is the difference between Total Savings Required at Retirement and Net Savings for Retirement in Future Dollars.