You may have seen the commercial on TV where one of the two guys discussing retirement says, “I will need a Bazillion dollars to retire.” Now, you may not need quite that much, but it is still imperative that you calculate how much you will need. In a previous blog post
we walked through the calculation for determining how much money is needed for retirement.
That calculation went something like this:
1) Determine how much monthly retirement income you will need in today’s dollars,
2) Subtract the monthly income you expect to receive from Social Security,
3) Determine what size lump sum would be required to fund the remaining income needs over your lifetime, and
4) Calculate the amount that should be withheld from each paycheck over the remainder of your working career to reach that lump sum.
While the math involved in this process is pretty straightforward, sometimes the amount of variation and uncertainty in the calculation can be overlooked. In this post, I want to focus on some of the risks that could affect your calculation.
The first risk is inflation. Most retirement calculators will use an assumed rate of inflation of 3-3.5%. This has been the average rate of inflation for the past 100 years, and thus is the best estimate for future inflation. However, a 100-year time horizon isn’t realistic and inflation has deviated significantly from that average over shorter time periods. If, for example, we experienced a three or four year period of double-digit inflation, the result could double the amount you need set aside. It would take many years of below average inflation to counteract that three or four year period. Possibly, the biggest risk we all face is: what will stuff cost when I am 80?
Another risk to your personal retirement calculation is the assumed growth rate that was included. Frequently a rate of 7-8% will be used to estimate market returns on your retirement savings. This also is a reasonable rate historically, but there have been prolonged periods (even as long as a decade) when markets significantly over or under performed that average. If you base your calculation on an assumed growth rate of 7%, about the only thing you know for sure is that your savings will not grow at exactly 7%. Part of this risk can be alleviated by diversifying across several different investment categories, but the future returns are always as unknown.
A frequently discussed, but difficult to quantify, risk to your financial future is your medical cost in retirement. Today, you may be in good health and also have good health insurance through your employer. However, as people age, their health is likely to deteriorate and in retirement people typically use Medicare for health needs rather than employer-offered coverage. Some people are surprised to find that Medicare still has premiums that must be paid and co-pays and deductibles that must be met before any benefits are paid out. In addition, there are many things that Medicare does not cover, such as long-term care (i.e. a nursing home stay). If these other costs are not insured against separately, they can eat through your retirement savings quickly.
What if you do everything right with your health and live to be 105? While it can be great to live a long life, it can also be a risk to your retirement nest egg. When you do a retirement calculation, it probably assumes that the funds will need to last for a 25-30 year retirement. However, some people will spend longer in retirement than they did in their entire working career. The average life expectancy is around age 83, but that is just the average; half the people will live longer than that. Since we don’t know which half we are in, we must plan as if we will be around for a while. If you spend 40+ years in retirement, it will require significantly more assets to maintain the retirement lifestyle you envision.
So how much do you need for retirement? For starters, save as much as you can. You will never be disappointed that you saved too much! The other key is to remember that your retirement calculation is not set in stone. It is a moving target that should be monitored and recalculated regularly. With each year that goes by, more uncertainty will be removed from the result, because you will have one more year of data on how much inflation increased, how the market performed, and how your health is. Even after retirement, reviewing this calculation should be an integral part of your annual review with your financial planner so that risks can be regularly assessed and addressed.
If you need help with this calculation or would like to discuss your retirement situation in more detail, give us a call at 800-234-9584 and ask to speak with one of our Certified Financial PlannersTM
. Your choice is your future!
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