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Calculating your retirement

If you retire at age 65, your retirement could last 30 years or more. And many of you would like to say adieu to the work-a-day world when you're in your 50s.

Will you have the financial wherewithal to do that?

Of course, that answer is determined by how much money is available in your retirement plan, Social Security benefits and any additional personal savings or investments. Will it be enough? The odds are, you don't know.

But experts say having a realistic estimate of how much income you'll need during retirement is key to a successful retirement plan.

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Think about the future
Only about a third of us take the time to calculate our retirement needs. The American Savings Education Council says people who calculate their needs are far more likely to hit the target than those who just plunk an arbitrary amount into a 401(k).

Unfortunately, too many people guess and shortchange themselves, according to Bob Barry, president of the Financial Planning Association.

"People have a weird concept of what they're going to spend money on. People who make $160,000 say they'll need $40,000 to $50,000 a year when they retire."

In fact, the person making $160,000 a year is likely to need at least $112,000 per year in retirement. That's right. For most of us it's best to count on needing 70 percent to 90 percent of our preretirement income to live comfortably.

The ASEC's annual retirement confidence survey shows 17 percent of workers believe they'll need less than half of their pre-retirement income, and another 25 percent expect to need no more than 60 percent.

Perhaps people underestimate their future needs because they're doing a poor job of saving for retirement and they'd rather not know how far off the mark they are.

The ASEC says less than 25 percent of those ages 40 to 59 have saved $100,000 or more.

A fair question is just how do you go about assessing your future income needs? Is it really as simple as determining 70 percent or 90 percent of your current income?

No. There's that pesky inflation factor. What return will your savings and investments generate? Will there be a long bear market in your saving years, or your retirement years? Do you want to travel the world and stay at first-class hotels or would you be happy renting an RV to visit Mount Rushmore?

And that's just for starters.

If you really want to get a grip on what you'll need for retirement, talk with an adviser, such as a certified financial planner.

"Your life should control your finances, not your finances control your life," says Barry.

"Spend time telling us what you'd like your life to be like in retirement and we'll tell you what you need to fund it. Be ready to spend a significant amount of time talking about what you've learned about money, what you're passionate about, what you want to do.

"If you went to the doctor tomorrow and found out you have five years to live -- and you'd be in pretty good health until then -- whatever is incorporated in that answer is what the financial planner should consider."

Seeing a planner is undoubtedly your best bet, but given that most of you probably aren't reaching for the phone book to find one, we'll look at an alternative that's a step in the right direction (and is free): a retirement calculator, the kind available on dozens of personal finance Web sites including this one.

"What's critical to a successful retirement is to get started as soon as possible. The calculations will show you how big the job is, and it's a really big job," says Stewart Welch of The Welch Group in Birmingham, Ala.

Go figure
One problem though is the calculators themselves. Some ask a lot of questions, others hardly any. Some will say you can retire at 60, others will have you working until you're 75.

Welch agrees the calculators have limitations, but says just going through the math is helpful.

"The fact that you can go to three different calculators and get three fairly significantly different answers isn't so problematic. It's a good idea to not assume one will give you the correct answer. What's really important is to go through the exercise, and it's even more important to repeat the exercise.

"Don't assume you're going to do a calculation now and find you have to invest $1,000 a month and just do that for 20 years. Review it on an annual basis. If we got on a plane for Seattle and set the initial course, we'd end up in the ocean if we didn't fine tune it along the way."

Michael Everett, professor of economics and finance at East Tennessee State University, says he's never been comfortable with any of the calculators he's tried on the Internet.

"I didn't know the assumptions they were using. Were they real returns, or nominal returns? You hear most stocks return 12 percent on average, but is it a real or nominal return? If you had $100 and got 12 percent, at the end of the year you could buy $12 more goods if it was a real return. But if it was nominal -- say inflation was 5 percent that year -- you'd only be able to buy $7 more goods.

"The next question is, what do you think the inflation rate will be? Well, how do I know?"

Everett would like to see software developers come up with more powerful and user-friendly calculators that would run varying portfolios -stocks, bonds, or balanced -- over different historical periods to see how they perform over good roads and bad roads.

"We could say let's retire you in 1928 and put all your money in stocks. Actually, you don't do too badly," says Everett. "You could do worse if you put all your money in stocks in 1965. It wasn't as deep but it was more prolonged. The market started down in 1928 and bottomed in 1933. In the '60s and '70s, the market started down in '68 and didn't recover until '89."

Everett says it's important to add a historical perspective when calculating retirement needs because we can't assume that history won't repeat.

"Our markets are extremely overvalued by historical standards -- much more so than 1929. The market could collapse or go sideways for 10 years. Look at Japan. We used to think they would take over the world. In the '80s their market went up threefold, in the '90s it collapsed threefold."

That type of analysis shows why Everett doesn't like to apply averages, as in returns, when it comes to individuals.

Averages, says Everett, are fine for pension managers.

"An individual is going to get a return in one specific period. A lot of advice is based on those averages. Averages look less risky. You average out the good and the bad so the returns don't fluctuate so much. But what happens for an individual could be much better or much worse. In general, an individual's risk is much greater than the average."

Whether you visit a planner or use an online calculator, you'll need to have a good idea of how much income you can expect in your retirement years. Each year, around your birthday, the Social Security Administration sends you a statement estimating the benefits you'll be receiving. Click here for calculators and other retirement planning tips from the Social Security Administration.

Another site that has several retirement calculators is Choose To Save.

-- Posted: April 29, 2002

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See Also
PLUS: What's your savings personality?
11 ways to save after retirement
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