Don’t Be Overwhelmed!
Solve for One Variable at a Time

 

by David D. Holland

 

Baby-boomers and many of those approaching retirement have a lot of the same questions: “How much do I need to save to retire? When can I retire? How much income can I have in retirement?” When faced with these questions, it can be hard to know where to start. One way to get some answers is to solve for one variable at a time. Here’s a real life example to illustrate the approach I would take:

 

Tips from 20 Years

Step 1 – We need to establish a few of the variables in order to solve for the others. If a husband and wife are both 50 years of age and both plan to work to age 70, then we know we have 20 years before the investments need to provide income (financial folks call this the “accumulation period”).
Step 2 – How much can be saved each year during the 20-year accumulation phase? The couple said they could save $20,000 a year.
Step 3 – How much can be earned each year? I recommend using 7% as an average, long-term rate of growth. 12% would be nice, but I caution against that high an assumption.
Step 4 – We can project what the couple could accumulate by age 70: $819,910. [Taxes have not been considered in arriving at this estimate because they will vary according to the couple’s situation and the type of account used to accumulate the funds.]
Step 5 – Retirement income can be estimated by applying a 4% withdrawal rate against the projected accumulated value in Step 4: 4% x $819,910 = $32,796 a year in retirement income. [Again, taxes are not considered.]

 

Rinse and Repeat: Now that you understand the basic process, you can change the assumptions and calculate different scenarios. If, for example, you want $40,000 a year in retirement income, then: 1. more needs to be contributed each year or 2. a longer accumulation period will be needed or 3. a higher growth rate has to be assumed or 4. a larger withdrawal rate will have to be used. If I hold all the other assumptions constant except for the annual contribution, then $40,000 a year in retirement income would require $1,000,000 to be accumulated by the end of the twenty-year period; that would require a $24,394 annual contribution each year.

 

This is just an overview of the process to estimate your needed savings. It’s a projection and isn’t guaranteed. As you near retirement, it is logical to move to more conservative investments, which could lower your assumed return.

 

 

 

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