The following is a staff writer post from MikeS. He is a married father of 2. So, with the cat, he ranks number 5 in the house. He loves numbers and helping people. Please leave any questions or comments below for either Mike or Crystal.
This article I found in The Wall Street Journal somewhat surprised me. It discusses how advisors are now counseling their clients, not on the size of their nest egg, but rather on how much income it might be able to generate. The surprising thing to me was that this is what I have been doing all along.
It was probably about 5 years ago, that I wanted to seriously analyze my retirement savings. I had some decisions to make and needed to figure out what my retirement savings would look like in 30+ years. I tried looking at various on-line calculators, but found myself disappointed in them. Essentially, the calculators weren’t robust enough for me. I couldn’t change some basic assumptions that were built into them. So, I built my own. It is simply an Excel spreadsheet that takes my assumptions and turns them into an income projection. The key to the calculations are the assumptions that I made in order to forecast 30+ years into the future.
The first thing I looked at was what retirement benefits my employer offered. The company provides a matching contribution to the 401k, along with a fixed percentage of salary contribution regardless of whether I contribute or not. The assumption I made here was that the plan would remain the same throughout my working career. Not very realistic, but it would be too hard to guess what the changes would be in the future. One thing to take note when looking at your plan, is what compensation is included in the employer match? Is it against base salary only? Are bonuses and overtime considered? My company made a change in the past year to include bonuses in the 401k. Not only am I now able to set a portion of my bonus aside in my 401k, but that the company also matches that contribution. So, essentially I receive a larger bonus.
The next assumption I made was related to my salary. How did I think it would change over time? I wanted to be a little conservative, but also have faith in my ability to grow my earnings. Here I decided to grow my salary at 4% every year from its current level. I felt this was reasonable given my track record since I graduated college. I have managed a 6% average annual growth over the last 15 years. I might change this in the near future, as my desire to advance up the corporate ladder has diminished. Keeping pace with inflation maybe a better assumption, I may have to revisit it next year.
The next decision I made was how my contributions would change over time. This was the biggest drawback I felt to the on-line calculators. I wanted to increase my savings over time. For me, I wanted to assume that I would increase my savings by 1% of my salary every year. The thinking is that when I receive a raise, I can raise my savings rate and not notice a decrease in my take-home pay. I’d like to say that I have been consistent increasing my savings every year, but that has not been the case. I have increased it in other ways, such as opening a healthcare savings account. I considered those savings as retirement funds as well, just not a 401k.
This is perhaps the biggest unknown. I assumed an average return of 9%. Some will argue that is overly aggressive, but I am comfortable with it. I feel like over the course of 30 years, I should be able to generate that level of return.
Here is another assumption that can have a huge impact. When I calculate what my savings will be in 30 years, what I need to know is will that be enough? I translate the future amount back into present dollars via the inflation factor. I used 3% as my assumption. That has been the historical rate of inflation and I felt it was a reasonable assumption.
Do I have enough?
In the end, trying to figure out if I have enough is just a guess. The bottom-line I looked at was whether my savings would be enough to generate an income equal to my take-home pay when I retire. I assumed a 4% withdrawal rate. I figure if I am living off my take-home pay just before retirement, then that amount should be adequate to retire on. As I get closer to retirement, I’ll have a better idea of what my spending will actually look like. Have you calculated your retirement number?