What income do you really need in retirement?
25 August 2006Penny Nickel over at Money and Values has run her numbers and thinks that people are generally overestimating the amount of money they’ll need in retirement. She’s in her twenties shooting for the number she’ll need 40 years from now - an admittedly hard thing to do. Her guess is she’ll need around $25,000 in today’s dollars based on her current lifestyle. I’ll play devil’s advocate with the post, however, and give a few reasons why you probably want to err in favor of a higher goal for your retirement income:
1) Marriage can change your situation. $25,000 may be enough for one person - but you could well get married at some time in the interim and need enough money for two people. And your spouse might not be quite so frugal.
2) Kids. Hopefully they’ll be out of your way by then, assuming you have some - but in your twenties you just don’t know what the situation will be, and there could be grandkids in the mix as well. There’s all kinds of ways that having grandkids can add to your expenses, but think of this common one: what if your kids or grandkids live across the country? Those travel expenses can rack up fast, and if you plan on saving to have just enough to get by, you may miss out on their childhoods.
3) Health Care Expenses. Some of these may not be covered by your insurance. My guess is that the costs continue to rise - as we get more treatments for things, there’s more and more for you to pay for. And there’s also little associated expenses that you may not think about - what if you need to remodel your house for a wheelchair?
4) Nursing Home. At some point in your life, you may have to go to one. For some people it can’t be helped. The difference in quality between what $25,000 a year can buy versus $50,000 a year can be enormous - the difference between surroundings that look like a hospital and those that look like someplace you’d actually want to live.
5) Stuff to do in Retirement. As a young person with a job, you don’t have as much time to fill up. You spend all day working. What happens when that goes away and you start getting bored? You either plop yourself in front of the TV or you find some hobbies - which may have expenses associated with them.
6) You may not be capable of pinching pennies when you’re older. The assumption is that she’ll still be able to be frugal enough not to need to spend much. But there’s a reason that old people are the most common targets for fraud. Part of it is that your mental acuity isn’t what it was when you’re 75 or 85. The other part is that at some point, you may find society passing you by in ways you don’t anticipate right now. Just think about the Internet and computers and how difficult those can be for anyone currently in their seventies or eighties. And I’ll bet that much of her current frugality requires some familiarity with them - you can save all kinds of money using all the tools that are available. But what if something even more revolutionary comes around - and you end up behind the tech curve?
These are the main reasons that I think people ought to err in favor of a higher number than $25,000, even if they think they can live on it.
I’ll also go ahead and say that I don’t think saving the amounts of money needed to generate a higher income is as difficult as she thinks it is, based on the personal information she discloses. I ran a quick Excel spreadsheet - she’s 24 years old, makes $47,000 a year, has $12,000 in current retirement savings, and is living on $15,000 a year plus her student loan expenses on 15k in loans.
I assumed she saves $5,000 a year for the next 40 years - not hard given her statistics, and I’d bet she could do a bit more without any difficulty. I assumed a 10 percent annual return - lower than what an index fund in the stock market has produced over the last 40 years, but about the return when you factor in inflation. What would she end up with? $2,756,074. Enough to give her about $137,800 in income - even though she only saved a total of $200,000 over that period.
You’re probably wondering how the heck that can be possible - unless you understand the idea of compounding. The real reason that she can easily save that much is because she’s 24, not 34. If she had to save for only 30 years, she’d end up with about $1,000,000 - if she had to save for only 20 years, only $367,000. If you’re starting young, you have a HUGE advantage - which is why everyone plans on having a six figure income in retirement if they’re 25 when they start saving. So my advice: go get a Vanguard index fund and start popping in that $5,000 a year - or a little more if you can afford it. Come 65, you’ll forget there ever was such a thing as penny pinching.
Discuss this on the Free the Drones Retirement Forums here.
One Response to “What income do you really need in retirement?”
August 26th, 2006 at 4:59 pm
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