Retirement planning involves looking ahead to determine how much money you need to save today. You also have to consider future inflation and your life expectancy. No one really knows what inflation will be or how long you’ll need your money to last. But you’ll want to estimate as best as you can.
Running Best and Worst-Case Scenarios
It’s best to consider both a success scenario and a failure scenario with the help of an online retirement calculator. Use the real rate of return in your planning. This is what you’ll get after the effects of factors like inflation and taxes. It may help to reassess and update your scenarios every few years since there are many variables involved.
Running Best and Worst-Case Scenarios
Some factors like the rate of return on your investments, your life expectancy, inflation, and your willingness to spend your principal will greatly affect how much money you’ll need for retirement.
Develop examples of best and worst-case scenarios to show the impact of these factors. Answers can be reached using spreadsheets and retirement planning software. An online retirement income calculator can also help you run an analysis.
Inflation and Life Expectancy
Inflation is a measure of what a dollar can buy at any given moment. Inflation is mostly discussed in relation to the Consumer Price Index (CPI). The Consumer Price Index is based on a standard basket of goods that economists decide most people will need and have to purchase.
Inflation tends to occur at a rate between 1.5% and 4% annually. Your dollar doesn’t buy much when inflation is high.
Life expectancy is the average number of years a person will live. Many factors are used to determine this number, including the region of the world you live in and your level of social welfare. The global average life expectancy at birth for the total population is 72.81 years, according to United Nations data.
Best-Case Scenario Example
Let’s say you need $50,000 a year to spend on top of your guaranteed income sources. These sources include funds from Social Security and guaranteed retirement accounts (GRAs). The assumptions for the best-case scenario are a 2% inflation rate, an average life expectancy of 25 years, a 7% inflation-adjusted rate of return on investments, and your willingness to spend your principal down to zero.
The programs tell us you will need about $585,000 to provide that inflation-adjusted income of $50,000 annually for 25 years. The inflation-adjusted return, also known as the “real rate of return,” removes the effects of inflation, taxes, and other expenses. It gives you an idea of what your investment return would be without external forces impacting it.
Worst-Case Scenario Example
Again, let’s say you need $50,000 annually on top of your guaranteed income sources. The assumptions for the worst-case scenario are a 4% inflation rate, an average life expectancy of 35 years, a 5% inflation-adjusted rate of return on investments, and you want to retain $700,000 of capital to pass on to your heirs.
Now the program says you will need about $950,000 to provide the same inflation-adjusted income of $50,000 annually for 35 years. Another significant factor here is that you don’t plan to spend your retirement money down to zero. But this allows you to pass the remainder on to your beneficiaries.
Note: An average life expectancy of 35 years is not a bad thing. But it means a longer period for which you need to rely on your retirement funds. You are likely to have less saved.
How Much Money Will You Need for Retirement?
Retirement planning is not an exact science when trying to determine how much money you will need in total retirement savings. The answer in these examples ranges from $585,000 to $950,000. But you may need more if you encounter worse conditions than your failure scenario.
Do not
You can’t know what inflation will be when you retire, what your rate of return will be, or how long you will live. You can’t get an accurate answer. The best you can do is provide a reasonable range of assumptions and make sure to reevaluate every few years.
You may want to seek help from a qualified retirement planner and do your own research to assist you in determining the correct assumptions to use. You will also want to consider the tax implications.
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Sources:
- U.S. Bureau of Labor Statistics. “Consumer Price Index”.
- MacroTrends. “World Life Expectancy Forecasts 1950-2021”.
Source: https://www.thebalancemoney.com/how-to-use-inflation-and-life-expectancy-assumptions-2388834
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