There are two phases of retirement planning: the accumulation phase, where you invest in building assets, and the withdrawal phase, where you draw down assets as an income.
Retirement planning is mostly focused on the accumulation phase. So, how much should you put away, and where should you invest? These are the most important questions. Firstly, you need to set a goal, a real dollar amount that you can visualize and create a plan to achieve. The process starts by answering three questions about your expectations for retirement. The questions are focused on your desired lifestyle, the length of your retirement, and the rate of return expectation.Â
What is Your Desired Retirement Lifestyle?
Your lifestyle is not about the size of your savings account; it’s about your income that won’t be changed after retirement. The first step in setting a retirement goal is to decide how much income you need to stop working. Are you okay to cut back and live simply, or do you see yourself living a life of luxury? The higher lifestyle you set for the future, the more money you need to set aside now. If you make $50.000 a year now, assume you want to continue to make the same amount after retirement and set that as your goal. $50.000 may sound like enough at age 65, but what about age 80. Prices tend to go up over time, so your calculation should include annual increases in your income. For example, if you assume a 2% rise in prices, your income in a year should increase to $51.000. The Federal Reserve has set a 2% inflation target for the US economy, so 2% is a good starting point.
What Rate of Return Can You Expect?
After retirement, you’re no longer accumulating assets but withdrawing from assets to create income. However, it doesn’t mean investing stops. Suppose you start with one million dollars in retirement assets, and you withdraw $100.000 out of that account in the first year. In that case, your remaining balance will be $900.000, but it will still be invested. If you achieve a 10% return rate, your account will grow back to $990.000 by the beginning of the second year, replenishing almost all of what you withdrew. The higher the rate of return you achieve in retirement, the less you need to save now.
Here is how the calculation works. If you decide you want $50.000 a year in income for 30 years (65-95), you need enough to provide 30 annual payments of $50.000. It’s pretty easy to calculate, but you also need to adjust your further payments for inflation by assuming an increase in your withdrawal rate every year.
