RETIREMENT Archives | Math for Grownups

On Wednesday, I showed you how to calculate the amount of money you’ll need in retirement — based on a variety of variables, including your pre-retirement income, the percentage of that income that you can live on in retirement and the number of years you expect to be in retirement. I even suggested that you find three or four goals for this — low, middle and high amounts — so that you have some realistic flexibility.

Even better is monitoring this savings along the line. Knowing what you should have already stashed away at age 30 or 40 or 50 can help you stay on track. If you’re behind, you can ratchet up your savings. If you’re way ahead, you can plan to quit your career a little earlier (or just bask in the really soft cushion you’ve created). Keeping an eye on these benchmarks helps you create a better plan.

But these calculations will naturally include a variety of assumptions — from how much you’re putting away in savings to the interest rates or return on investments. There’s no good way to really predict these, but retirement ratios have gotten pretty good reviews from some financial experts.

Retirement Ratios

Charles Farrell (not the silent film star) of Northstar Investment Advisors created a set of multipliers, outlined in his book, Your Money Ratios, that make it really simple to estimate these benchmarks. (In this case, multipliers are merely numbers that you multiply by. In essence they’re parts of proportions.) Like my suggestion to have several goals, Farrell developed bronze, silver and gold standards. (Bronze is 70% of income, retiring at 70 years old; silver is 70% of income, retiring at 65 years old; and gold is 80% of income, retiring at 65 years old.) His website and book detail these standards and benchmarks in really handy tables.

Basically, Farrell offers multipliers for each standard and each age. Pull the multiplier from the table, multiply it by your salary and — viola! — you have easily calculated a good estimate for how much you should have already saved by that age and for that standard.

Let’s look a simple example: retiring at age 70, with 70% of your income. And let’s say you earn $50,000 a year. Here are four multipliers from Farrell’s tables: 30 years old at 0.45, 40 years old at 1.6, 50 years old at 3.5, 60 years old at 6.5 and 70 at 10.

30 years old: $50,000 • 0.45 = $22,500

40 years old: $50,000 • 1.6 = $80,000

50 years old: $50,000 • 3.5 = $175,000

60 years old: $50,000 • 6.5 = $325,000

70 years old: $50,000 •10 = $500,000

It’s not at all clear how Farrell came to these multipliers. (And I’m certain, like KFC’s secret recipe, he’s going to keep much of that to himself.) But, mathematically speaking, there’s something interesting to notice here. Your benchmarks are 10 years apart, but the difference between each goal is not a constant number. In other words, the difference between each consecutive year is not the same number.

Why is that? Well, if you think of the graph of compound interest, you’ll come to the answer quickly. Because compound interest is a curve, it increases quickly. This is a great thing when you’re dealing with savings. (It’s not so good with credit.) And if you look at the difference between each benchmark, you’ll see that over time, you’re retirement investments and savings are increasing by more and more.

And this should make perfect sense, if you look at the multipliers. These are not increasing in a constant way, either.

1.6 – 0.45 = 1.15

3.5 – 1.6 = 1.9

6.5 – 3.5 = 3

10 – 6.5 = 3.5

Each difference is slightly larger as you go up in age. If you were to graph the age and multiplier (or even product) on a coordinate plane (x-y axis), you’d have a curve.

The bottom line is this — as you age, you want your nest egg to increase exponentially, rather than linearly. In other words, you want your total to increase quickly, so that you can reach your retirement goals before you’re too old to take advantage of them.

What do you think of this process? How would having these benchmarks help you monitor your retirement savings more closely? Do you think it would be helpful to use these multipliers in your planning? Share your responses in the comments section.

With a presidential election comes big speeches about Social Security and Medicare. But if you’re a cynical 40-something (or younger) like me, you’re not planning on being able to depend on those programs being viable in 20 or more years. Nope, I figure my ability to retire will rest entirely on my shoulders.

But what does that mean? How much will I need to squirrel away for my golden years? Turns out the experts offer some advice.

First off, you won’t need 100% of your salary when you retire. Depending on their situations, most retirees live on between 70% and 80% of their pre-retirement incomes. Once you decide on that percentage, you can easily calculate the amount you’ll need to have on hand when you retire.

(Editor’s note: A reader let me know that it’s unclear what I mean by savings. For our purposes here, I’m discounting Social Security and pensions, since most of us don’t have pensions and there’s no guarantee that Social Security will still be around. At the same time, I am including investments like IRAs and 401K plans. These have largely replaced pension plans and are the most often recommended ways to save for retirement. Now back to our regularly scheduled program.)

Let’s say that you earn an even $50,000 each year. You’re a conservative sort, who figures that having 80% of that each year is a better cushion. Find 80% of $50,000 to find your annual retirement income. (In case you’ve forgotten, of means multiplication in this situation. So you’ll need to multiply 80% — or 0.8 — by $50,000 to get your final answer. Using a calculator works just fine.)

80% of $50,000

0.8 • 50,000 = 40,000

In this scenario, you’re shooting for $40,000 in the bank for every year you are retired. And that’s where the tricky part comes in. There’s no way to know for sure how many years of retirement you’ll actually have. People are living longer, which is one reason that the actual retirement age is creeping up.

But let’s assume that you are expecting the average 20-year retirement. (That sounds heavenly!) The rest of the math is incredibly simple. Just multiply the annual retirement income by the number of years:

$40,000 • 20 = $800,000

Yep. You read that right. With a modest $50,000 annual income, it’s reasonable to expect you’ll need $800,000 in the bank before you can spend your days volunteering at the hospital gift shop or planting daisies. (This is why most folks can’t afford to retire.)

So with just these simple calculations, let’s play with the numbers. What if you reduce the percent to 70% and keep the retirement time the same?

0.7 • 50,000 = $35,000

$35,000 • 20 = $700,000

What about keeping the percent the same and reducing the retirement time to 15 years?

0.8 • 50,000 = $40,000

$40,000 • 15 = $600,000

Let’s try one more idea: reducing both the percent and retirement time.

0.7 • 50,000 = $35,000

$35,000 • 15 = $525,000

This exercise isn’t really a waste of time. (I promise.) With these four figures, you have several goals to shoot for — lowest, middle and highest goal. (Of course, having even more than $1.2 million is just fine.) And with those three goals comes more flexibility in your savings options. If you shoot for 70% of your pre-retirement income and plan to spend 15 years in retirement, you’ll need $525,000 in savings. If you shoot for 80% and 15 years, you’ll need $600,000. At 70% and 30 years, you’ll need $700,000, and at 80% and 30 years, you’ll need a cool $800,000.

Of course deciding where to invest or save your hard earned cash is a whole ‘nother ball of wax. But knowing what you’re shooting for is a great start. Otherwise, you could miss the retirement boat completely.

Come back on Friday to get the scoop on benchmarking your retirement savings. In order to meet your goals, how much should you already have in savings at 30 years old? 40 years old? We’ll check the math.

Were you surprised to see these figures? Where they higher than expected or lower? Share your thoughts in the comments section.

RETIREMENT

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