This week Money Mondays is going to last for three days: Retirement Planning for Beginners in three steps. I'm pleased to publish a guest post series by reader and frequent comment contributor, D. G. Pratt. DGP (as he is known in the comments section) retired over a decade ago at the age of 45, so his retirement strategy has been well tested, surviving not one but two nasty bear markets. Monday he covered the basics of creating a budget, yesterday how to figure out how much you'll need, and today, putting that all together.
Where we left off yesterday
But, what if you want to retire early, that is before you reach Social Security age? For the time, however long you want to make it, between your actual retirement age and your Social Security age (generally about age 66 to 67) you will need to fund your living expenses entirely from your nest egg. So long as the savings that remain by the time you reach Social Security age are enough to fund your retirement income you will be ok. Therefore, your nest egg needs to be somewhat larger to pay for the extra years of retirement.
For example: your retirement budget is $30,000. Your anticipated Social Security benefit is $10,000 per year. The difference, $20,000, will need a nest egg of $500,000, as described yesterday. Suppose your Social Security age is 66 but you want to retire at age 55. You will need to fund your retirement for 11 years before Social Security kicks in. You will need additional savings to provide for the $10,000 per year for 11 years. The simplest way to calculate this is to just multiply $10,000 by 11 for a figure of $110,000. That number is actually a bit of an overestimate because that money will be generating income until it is spent, but this is a good rough estimate of what you need. So, $500,000 plus $110,000 equals $610,000. That is the nest egg you would need to retire at 55 at an income of $30,000 per year, inflation adjusted, for the rest of your life, assuming a 4% real investment return. [Using a 3% real return you would need $666,000 plus $110,000 for a total of $776,000.]
Step 3: Keeping Score
Now you know how much you need. How are you doing? Add up your assets, subtract your liabilities (debts) and you will get your net worth. Some of that will be your house. Subtract the cost of a house in the area you expect to be retiring to. The result is the current size of your nest egg. Too small? You have several options. You can revisit your budget and see if you are willing to live a little more frugally when retired. But most people will just have to tighten their belts to save more (or get those kids out of the house so that you can really start to save!). And you can check your mix of investments to see if you can grow the money you already have a bit faster. At least now you know what target you are aiming for!
To continue to keep track of your progress I suggest that you revisit your retirement budget every few years and plug in current costs and estimates of what you will need to live, since they will be increasing with inflation. Then you can generate a new estimate of what your nest egg will need to be. Your savings and investments should be growing more quickly than the inflated size of the nest egg that you project that you will need.
Good luck!
Thanks to DGP for the great series, Retirement Planning for Beginners!
Related Posts:
Retirement Planning for Beginners: Part One
Retirement Planning for Beginners: Part Two
Don't Let Fear Paralyze Your Retirement Plan
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