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Looking at Retirement Income Needs
By JLP | April 21, 2008
This is a follow up to my previous post, Common Questions: How Much Do I Need to Save for Retirement?.
One way to look at retirement needs is to estimate how much income you will need over the life of your retirement. Using the numbers from the previous post, we’ll assume that your inflation-adjusted first-year income need is $182,045. If we assume a 3% inflation rate, in year two of retirement, you will need $187,506. Over 25 years, this is what the income needs would look like:
Based on these numbers, we can see that the total income needs over a 25-year retirement are over $6.6 million. Fortunately, you don’t have to have all $6.6 million available to you the first day of retirement. Why? Because you will most likely be able to invest your money so that it will grow during retirement. That means that we need to adjust each year’s income needs to reflect the growth of the retirement account. In financial terms, we need to discount the future cash flows by our expected rate of return using this formula for each year’s income need and then add the results together to arrive at a present value for the income stream:
PV = FV ÷ (1 + ROR)N
where…
PV = Present Value
FV= Future Value
ROR = Expected or Required Rate of Return
N = Year of the Cash Flow
For example, we’ll discount Year 2’s income need using a 7% expected rate of return. Using the formula above, the equation looks like this:
PV = $187,506 ÷ (1 + .07)
PV = $187,506 ÷ 1.07
PV = $175,239
Year 3’s income need would be discounted like this:
PV = $193,131 ÷ (1 + .07)2
PV = $193,131 ÷ 1.072
PV = $193,131 ÷ 1.14
PV = $168,688
Repeating this for each year’s income needs, we get the following:
So, this tells us that if you retired at age 65 with a balance of $2,991,080, you could withdraw your first year income need of $182,045, and increase each year’s income need by 3% for 25 years IF your account value grows at 7% per year.
As we all know, this is just a hypothetical illustration. Some years your account will grow by more than 7% and some years it will grow by less than 7% or it could even lose value at which point you would have to assess your situation and decide what action you would want to take. The important thing is to not be too aggressive with your expected rate of return. You can also run the calculation using a lower expected ROR during retirement. I used 7% as I think it is a fairly conservative estimate.
Topics: Retirement Planning | 8 Comments »
April 21st, 2008 at 12:58 pm
I think you mean FV = PV * ((1+ROR)^N).
April 21st, 2008 at 1:11 pm
CD,
Oops. I meant to use the division sign but used the code for the multiplication sign instead (that’s what I get for trying to go from memory instead of looking up the HTML code). It’s fixed now.
April 21st, 2008 at 5:27 pm
You need to lower your expected rate of return during retirement years because the older you get, the higher percentage of assets you’d want to have in “safe” accounts which means lower return rate. You cannot continue to keep most of your assets in stocks when you are over 70 as if the crash happens you’ll not have enough money to “survive” until the prices go back up. Don’t forget that it took until the Second World War for the stock prices to get where they were pre-1929 crash. If you were 70 in 1929 keeping all the money in mutual funds wouldn’t have been such a smart idea.
April 21st, 2008 at 5:31 pm
Nice post. Retirement income is the new buzz word around work. All those boomer assets just waiting to be captured…
We’re working on a product solution that offers a blend of guaranteed lifetime annuity and lifetime funds (or make-your-own blend) in an attempt to meet retiree income needs without building an 100% “do it for me” solutions. I’d love your thoughts on that.
The thing about retirement income is that it really depends when your “low years” hit. If you realize 3-4% returns (or *gasp* negative returns) the first few years of retirement, you have a lot less to live on in the future unless you realize 12% – 15% for several subsequent years (these are hypothetical numbers I’m just pulling out of the air, but you get the idea). Someday I will bother to run the actual numbers…
April 21st, 2008 at 7:39 pm
Assuming inflation only in the formula is unwise. I personally can never buy into this propaganda by the financial industry. With lot of lenders bankrupt or to be bankrupt, liquidity is eliminated. Consequently, deflation is no longer a distant probability.
Listed below are 222 failed lenders since late 2006:
1st Choice Mortgage
ACT Mortgage
AMC Lending
Aapex Mortgage (Apex Financial Group)
Accredited Home Lenders, Home Funds Direct
Acoustic Home Loans
Aegis
Alera Financial (Wholesale)
All Fund Mortgage
Alliance Bancorp
Alliance Mortgage Banking Corp (AMBC)
Allied Lending Corp. (Wholesale)
Allstate Home Loans / Allstate Funding
Alterna Mortgage
Alternative Financing Corp (AFC) Wholesale
Altivus Financial
American Freedom Mortgage, Inc.
American Home Mortgage / American Brokers Conduit
Ameriquest, ACC Wholesale
Ameritrust Mortgage Company (Subprime Wholesale)
Amstar Mortgage Corp
Axis Mortgage & Investments
BF Saul Wholesale Lending
BNC Mortgage (Lehman)
BSM Financial
Bank of America (Wholesale)
BayRock Mortgage
Bridge Capital Corporation
BrooksAmerica Mortgage Corp.
Bryco (Wholesale)
C & G Financial
CFIC Home Mortgage
CIT Home Lending
Calusa Investments
Capital Six Funding
Castle Point Mortgage
Charter One (Wholesale)
Chevy Chase Bank Correspondent
Choice Capital Funding
Citigroup – FCS Warehouse
Citimortgage Correspondent (2nds)
Clear Choice Financial/Bay Capital
Coast Financial Holdings/Coast Bank
Coastal Capital
Columbia Home Loans, LLC
ComUnity Lending
Community Resource Mortgage
Concord Mortgage Wholesale
Concorde Acceptance
CoreStar Financial Group
Countrywide Financial Corp.
Countrywide Specialty Lending
Dana Capital Group
Decision One (HSBC)
DeepGreen Financial
Delta Financial Corp
Deutsche Bank Correspondent Lending Group (CLG)
Diablo Funding Group Inc.
Dollar Mortgage Corporation
DomesticBank (Wholesale Lending Division)
E*Trade Wholesale Lending
ECC Capital/Encore Credit
Eagle First Mortgage
Edgewater Lending Group
Empire Bancorp
Entrust Mortgage
EquiBanc
EquiFirst
Equity Funding Group
Exchange Financial (Wholesale)
Expanded Mortgage Credit Wholesale
Express Capital Lending
FMF Capital LLC
Family First Mortgage Corp.
Fieldstone Mortgage Company
First American Bank (Wholesale)
First Consolidated (Subprime Wholesale)
First Fidelity Financial
First Horizon Subprime, Equity Lending
First Indiana Wholesale
First Madison Mortgage
First Magnus
First Mariner Wholesale
First NLC Financial Services
First National Bank of Arizona
First Source Funding Group (FSFG)
First Street Financial
FirstBank Mortgage
FlexPoint Funding (Wholesale & Retail)
Flick Mortgage/Mortgage Simple
Foxtons, Inc.
Freestand Financial
Fremont General Corporation
FundingAmerica
GEM Loans / Pacific American Mortgage (PAMCO)
GreenPoint Mortgage – Capital One Wholesale
Group One Lending
H&R Block Mortgage
HSBC Mortgage Services (correspondent div.)
Harbourton Mortgage Investment Corporation
Heartland Wholesale Funding
Heartwell Mortgage
Heritage Plaza Mortgage
Home 123 Mortgage
Home Capital, Inc.
Home Equity of America
Home Loan Specialists (HLS)
HomeBanc Mortgage Corporation
Homefield Financial
Homefront Mortgage Inc.
Homeland Capital Group
Honor State Bank
Horizon Bank Wholesale Lending Group
Impac Lending Group (Wholesale)
Innovative Mortgage Capital
Investaid Corp.
Ivanhoe Mortgage/Central Pacific Mortgage
Kellner Mortgage Investments
Kirkwood Financial Corporation
Lancaster Mortgage Bank (LMB)
Lehman/Aurora Loan Services
Lender’s Direct Capital Corporation (wholesale division)
Lexington Lending
Liberty American Mortgage
LoanCity
Long Beach (WaMu Warehouse/Correspondent)
LowerMyPayment.com
LownHome Financial
MILA
MLN
MLSG
Madison Equity Loans
Mandalay Mortgage
Maribella Mortgage
Marlin Mortgage Company
Master Financial
Maverick Residential Mortgage
Mercantile Mortgage
Merit Financial
Meritage Mortgage
Millenium Bankshares (Mortgage Subsidiaries)
Millenium Funding Group
Mortgage Investors Group (MIG) – Wholesale
Mortgage Tree Lending
MortgageIT-DB (Retail)
Mylor Financial
Nation One Mortgage
National City Corp. (Wholesale)
Nations Home Lending
Nationstar Mortgage
NetBank Funding, Market Street Mortgage
New Century Financial Corp.
New State Mortgage Company
No Red Tape Mortgage
NovaStar, Homeview Lending
Oak Street Mortgage
Opteum (Wholesale, Conduit)
Optima Funding
Option One – H&R Block
Origen Wholesale Lending
OwnIt Mortgage
PNC Bank H.E.
Paragon Home Lending
Paul Financial, LLC
People’s Choice Financial Corp.
People’s Mortgage
Platinum Capital Group (Wholesale)
Popular Financial Holdings
Popular Warehouse Lending
Preferred Advantage
Premier Mortgage Funding
Premium Funding Corp
Priority Funding Mortgage Bankers
Pro 30 Funding
Quality Home Loans
Quick Loan Funding
ResMAE Mortgage Corp.
Residential Mortgage Capital
Right-Away Mortgage
Rose Mortgage
SCME Mortage Bankers (Wholesale)
Sea Breeze Financial Services
Sebring Capital Partners
Secured Bankers Mortgage Company (SBMC)
SecuredFunding
Silver State Mortgage
Solutions Funding
Soma Financial
SouthStar Funding
Southern Star Mortgage
Sovereign Bancorp (Wholesale Ops)
Spectrum Financial Group
Starpointe Mortgage
Steward Financial
Stone Creek Funding
Summit Mortgage
Summit Mortgage Company
Sunset Direct Lending
Sunset Mortgage
The Lending Connection
The Lending Group (TLG)
The Mortgage Store Financial
The Mortgage Warehouse
TransLand Financial
Transnational Finance Wholesale
Tribeca Lending Corp. (Wholesale)
Trojan Lending (Wholesale)
Trump Mortgage
UBS Home Finance
Unlimited Loan Resources (ULR)
Valley Vista Mortgage
WAMU Comm. Correspondent
WMC
WaMu (Subprime)
Wachovia Mortgage (Correspondent div.)
Warehouse USA
Webster Bank (Wholesale)
Wells Fargo (various Correspondent and Non-prime divisions)
Wells Fargo – Home Equity
Wescom Credit Union
Winstar Mortgage
Zone Funding
April 21st, 2008 at 10:00 pm
Why not do everything in present value, i.e. in today’s money? Let’s say I expect when I retire to no longer be paying my mortgage (which will be gone) and not be contributing to my IRA or 403(b).
I really could live on perhaps 80% of my income. My income will be larger then, because it will have grown, but money will also be worth less. Say 20% of my income comes from social security, and 20% comes from my pension.
I have to account for 40% of my income out of retirement assets. I don’t know what the income will be, but why not assume that whatever it will be that it has a present value the same as my current income (or 1.5 times my current income if you like to think I’ll have raises that exceed inflation–use the multiplier that makes you happy).
Nice round number example: If my present income is $50000, then I’ll need to provide for 40% of that, or $20000 from retirement assets. Let’s say, I apply a standard 4% withdrawal rate. Then I’ll need savings amounting to $20000/0.04 = $500000. That’s $500000 in today’s dollars, i.e. present value, not $500000 when I actually retire–it will actually be more then because of the inflation process.
I have to decide how much my investments will return, but how about 6% after inflation (choose lower returns to be more conservative).
If I intend to retire in 16 years, but I already have $70000 saved, then I need annual savings P so that the remaining $430000 = P(1-1.06^17)/(-.06) or P = $15241 in today’s money. I should save about $15000 this year to be on track.
They joy of working in present value, is that you already know the present value of your assets, and the present value of your current income and you need to know the present value of your savings rate, i.e. what you need to save this year. Next year when there’s been a bit of inflation the numbers will be different, but you’ll still know the new present values and be able to repeat the process exactly the same way.
April 22nd, 2008 at 5:38 am
I am afraid to say that I will be 35 soon and have no retirement plan. I aim to pay off my mortgage and then use my extra income to fund investments which should provide me with enough passive income to keep me going through my retirement and give me something to hand on to my children. I am sure many think this is a foolish idea but I hate the thought of paying into a pension and then having nothing to pass on to the children.
April 22nd, 2008 at 7:25 am
I agree with Don – using present day values is much better. I did a post on this a while back.
Mike