Tuesday, August 15, 2006

Retirement Planning in Your 20s (& Beyond), Part 1: Estimating Annual Retirement Expenses

It seems like most advice for young people planning for retirement consists of "save as much as you can now, and figure out how much you'll actually need later." Your 20s is a great time to save and take advantage of the wonders of compounding interest-- and there are so many variables involved in predicting future retirement needs-- so this is quite good advice, if it satisfies you.

The problem is, it doesn't satisfy me! I really like having goals, targets, an idea of where I'm going and how well I'm doing. So as challenging as it seems, and even though it's probably an unnecessary step at my age, I still want to come up with "my number," even if it's one that gets revised many times in future years.

That's what this brief series of posts will be about: me stumbling towards an estimate of how much I need to accumulate for my retirement, and hopefully finding it a little simpler than those crazy calculators that always ask questions I don't know the answer to. Feel free to play along at home, but please note that I am not an expert, and in fact would absolutely love any suggestions or information from you to help me along in this process. (Also, these steps should work just as well for people in their 30s and beyond; it's just that it seems like you've all done this already!)

For starters, I want to try to estimate how much income I'll need in retirement. (All numbers will be in 2006 dollars for now, and we'll adjust for inflation later.) I see so many people talking about wanting six-figure retirement incomes: $100,000, $200,000, sometimes even more. When you run the numbers, the amount you need to save to produce those amounts seems astronomical and overwhelming. (Although doable for some people, I'm sure.)

But those don't feel right to me. One common suggestion to calculate your retirement expenses is 80% of current expenses. 80% of my current expenses (not counting student loan payments) would come out to about $12,000 a year. Which sounds really, really low. Maybe my current style of living is way off from what I'd want in retirement; even though I bet I'll continue to be frugal, there are probably some inconveniences I'll no longer be willing or able to put up with to save a buck or two.

Then I found this data from a study of older Americans. It finds that the average expenses of a married person over 65 was $14,762 in 2001. Maybe I'm not so far off! And even for couples in the top 20% of income, average expenses (per person) was $25,567, spending about 1/4 of that on entertainment and gifts. (There's all sort of interesting data in the report to help you think about what you might end up spending; all the tables in the appendix are a great place to start.)

Based on these numbers, I think I'm going to go ahead and use $25,000 as my yearly expenses/income-needed number (in 2006 dollars; I promise I'll adjust for inflation later!). If it's (almost) enough for the average person in the top 20% of income, it ought to be more than enough to cover a frugal-minded little old lady like me. And it's more like 160% of my current expenses, rather than 80%. I feel like my expenses might actually end up lower in reality, but I might as well play it on the safe side in these estimates.

For those of you who've done this step, would you be willing to share what you came up with as your annual retirement income, in dollars or as a percent of current income? Or maybe just talk about the process you used to come up with it? I don't think I've ever seen anyone talk about a number in the ballpark of my $25K; is yours anywhere near it, or do you think I'm crazy? And for those of you reading who've never tried this-- play along at home! What do you come up with?


Tiredbuthappy said...

Penny, good for you for trying. I still feel like it's too far away, and how can I possibly know how much I'm going to need?

It's a good idea to look at what elderly people actually spend. But 25K in today's dollars seems so very low. I think I could live on that in today's dollars if my house was paid off and if I didn't travel much, but what would the point of retirement be if I couldn't travel much?

The thing that I find hard to face is that all this frugality now will not eliminate the need for frugality later. It's not like, pince your pennies now, and then just relax and spend whatever you want in retirement. Instead, I have to pinch my pennies now so that I have some pennies to pinch in retirement.

Frugality is like eating a low-fat diet. It's a lifestyle choice that NEVER ENDS. You can't reward yourself later for all your hard work without undoing the good you've done.

Harrison said...

My target is retire early and financial free before age of 30. So I already done my estimation on annual retirement expenses which I need around $60,000 per year. This amount of money will support me to take care of my whole family and let me have extra money to invest. I know there are a lot of things have to do and fast trying to retire early, especially before 30, but I will do my best to fulfill this because this is my dream.

Penny Nickel said...

Good points, Claire. Anyway, I certainly hope I wouldn't have mortgage payments in my 60s and 70s! I was assuming just property taxes and homeowners insurance on the housing front. I think I could fit a decent amount of travel into the $25,000, although there'd have to be limits. But I'd like to do a lot of traveling while I'm still younger, anyway.

Kira said...

I hadn't really thought about it that way - my retirement planning estimates were based off of an income of $50,000 in today's money, but if I've followed my other planning ideas, I won't have a mortgage or any other loan payments (certainly not student loans!) and the biggest thing I forgot about - TAXES. Of course, healthcare will cost as much then as my taxes do now, at least, so it might be a wash.. But if I put the majority of my money in Roths over the years, I should only be paying a small amount of money in taxes. So $50k will buy a LOT more untaxed. Maybe I will re-do my retirement number...

mOOm said...

My current expenses at age 41, single and pretty frugal but not exactly watching every dollar are around $25k per year. So I don't think it is a bad number to hit for as a minimum. It is going to depend on where you live though. Of course the total amount for a couple should be something like $40k. These numbers are close to expenditure possible on average US salaries and household incomes.

When people tell me they need (rather than want) huge amounts in retirement I give my mother (who is 75) as a counterexample. Her net worth is between $2 and $2.5 million (and only $125k is the value of her apartment). She also receives government pensions - like social security from Britain and Germany which amount to about $1000 per month. And most of the time that is what she spends. She only dips into the income from her investments for special expenditures. I keep asking her whether she doesn't want to spend more money. She lives in Israel but I don't think the cost of living is much different there to the US.

Lee Matthews - Financial Concepts West said...

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