Your Retirement Target: How Much is Enough?
When you enter your 40's, a persistent question often arises: Am I saving enough for retirement? If you find yourself asking this, you will figure out a plan. However, if you're in your 40's and not yet thinking about retirement planning, you might be avoiding it because retirement planning needs some effort.
There are tons of calculators on internet to calculate whether you are on track for retirement or not. But most of them need lot of information to punch in. Also, they might not reveal the calculations behind the number they gave us. In this article, I want to articulate one simple calculation to get a ballpark number with the least amount of information needed. You need only the following information.
- What is your current annual family expenditure?
- How many years away are you from retirement?
- Approximate years of your retirement party?
What is your current annual family expenditure
Simply calculate how much money today you need for your family annually. Don't think like I pay this much for my kid's classes today, but during retirement they won't be there.. etc. You might not have some types of expenditure you do now but during retirement you will get some new expenditure like healthcare. So, simply find out your current family expenditure for a year.
How many years away you are for retirement?
You don't need age to retire. You need money to retire. So, typical 65 need not be your retirement age. It depends on what you want to do after retiring. So, think a bit and put a number for your retirement age.
How many years will be your retirement party
If you retire at 60, then your retirement party might be for 30 to 40 years. So, just have that number. Some people will say, I just want to plan till 70 years. But when calculating your financial number for retirement, assume full life. No one should die because they don't have enough money during retirement. It's better to plan to leave some money to pass it to your next generation.
Calculate the magic number
Your magic number is
Your projected yearly expenditure by retirement * number of years in retirement.
It's as simple as that. Only one tweak you need to do is to calculate your projected yearly expenditure by retirement. The key factor to consider in this calculation is the inflation.
You projected yearly expenditure by retirement is
current expenditure × (1 + Inflation Rate × Number of Years to retirement)
In the USA, considering how the last 5 years were, we can take average inflation as 4%. So, the inflation rate will be 0.04. In India, probably the inflation rate is 0.05 to 0.06.
Let's assume your family need is $100,000 per year today and you are 18 years away from retirement. First step is to calculate your future expenditure adjusted to inflation.
current expenditure × (1 + Inflation Rate × Number of Years to retirement)
100,000 × (1 + 0.04 × 18)
100,000 × ( 1 + 0.72)
100,000 × (1.72)
172,000
Now your magic number is 172, 000 × number of years in retirement.
Say your number of years in retirement is 30.
172, 000 × 30 = 5,160,000
You will need nearly 5 million for your retirement.
So, look at your retirement accounts (401k, IRA) and other accounts marked for retirement and see whether you are on track for retirement. You need to add some buffer for taxes. Suggestion is to add around 30% in the USA for taxes. If you are in India, your taxes might be bit low during retirement because withdrawals from retirement accounts like provident fund are not taxed in India as of 2024.
That's a wrap this week.
Happy learning!
