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Step 1
Determine the annual income needed during retirement. Total all expected expenses needed during retirement. One method for totaling expenses is to update the current annual budget to reflect what it will look like in retirement. Include mortgage or rent payments, utilities, food, recreation, insurance (health, home, auto), clothes, loans/car payments, inheritance for descendants and any other expenses.
Another method is to take 80 percent of the current income. This is a common estimate amount because many believe their expenses will decrease in retirement. If you believe they will go up, increase the percentage.
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Step 2
Adjust the annual retirement income for inflation. Determine how inflation will impact the amount needed for retirement.
Example: Mark believes the expected inflation rate of 4 percent will remain constant.
Future income needed = present value of income ÷ (1÷ (1+ inflation))n , n= # of years until retirement.
$162,180 = $50,000 ÷ (1÷ (1+.04)30)
This is the annual income Mark will need in retirement.
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Step 3
Estimate how long you need retirement funding. Start with your current age and estimate how much longer you will live. There are life expectancy charts that, given the birth date, will display the estimated number of years until death (see Resources below).
Example: Mark is 35 years old, and his life expectancy is an additional 44 years. He intends to retire at age 65, so he will live about 14 years after retirement (35+44=65).
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Step 4
Calculate the total amount of income needed for retirement. Add up the annual income needed for retirement and adjust it for interest that will be earned on it during retirement and the inflation it will endure during retirement years.
Example: Mark believes he can earn 6 percent interest on his retirement funds during retirement, and that the inflation rate of 4 percent will remain constant.
$162,180 for 14 years, earning 6 percent with an inflation rate of 4 percent:
i=(1- (1.04 ÷ 1.06)14) ÷ (.06 -.04) = 11.7050
$162,180 x (1+.06) x 11.7050 = $2,012,216
The total amount Market will need for retirement is $2,012,216.
