One of the most common questions I receive in my practice, is that concerning retirement planning. For many of us, retirement seems a distant future and one which many people do not concern themselves with. Hopefully this will change that belief.
It is safe to say that apart from your house, your pension would probably form the largest asset you own/benefit from. In order to calculate your future target amount we need some facts and as always, some assumptions.
I am going to walk you through the steps in calculating how much money you need in retirement. Hopefully you can run your own calculations as we progress. It is my desire that everyone knows what their target is.
Firstly, we need to ascertain how much money you need in retirement. Imagine you could retire tomorrow, how much money would you need to lead a comfortable lifestyle. Remember, the 8 hours (or more) of work which you were performing now need to be filled up with leisure activities, and hence many people feel that more money would be required in retirement. Another way you can determine this amount is by asking yourself “how much more money than my current net income would I like in retirement?”.
Let’s assume your monthly figure is €2,500 per month, annualised this would be €30,000. However, as they say “the devil is in the detail.” In this instance, that detail is inflation. Inflation is simply the rate at which the price of goods increases year on year. Remember when you went with your father to the bar for your first beer (well, at least HE thinks it was your first beer). How much did it cost back then? €1,50? Nowadays you are lucky if you can find one for less than €4,50. That, ladies and gentlemen, is inflation.
Also, we need to determine how long until your retirement before we can fully appreciate the effects of inflation. Lets assume you have 25 years until you would like to be in a position to retire (financial freedom). We can now fully incorporate the effects of inflation using our beloved formula FV=PV(1+r)^n.
This calculation works out the future value (FV) of present day money (PV), at an assumed rate of inflation (r) over a pre-determined period of time (n). In our example the future value of €30,000 over 25 years (assuming an inflation rate of 2.5%) is €55,618. This means that in 25 years time, at an assumed rate of inflation of 2.5%; €55,618 would purchase you the same goods as €2,500 would today.
This is now your targeted annual income in retirement. The next step would be to calculate where this income is to originate from. That will be dealt with in a future blog post and once published it will be referred to hereunder. If you can’t wait until then, of course – feel free to send me a message and I would love to walk you through the steps.