From a financial point of view, the most important question to ask when planning for retirement is “how much money do I need to retire on”. Here are the points that need to be considered when making a retirement plan.
How long does the money need to last? A person who is going to retire at 80 will certainly not need as much money as would be needed if retiring at 50. It is usual to not know how long exactly the money will be needed until, but it is easier to predict with a projected timeline. For example: If you retired at 65, and expect to need money until you are 90, your money needs to last for 25 years.
How much money should be left over when I die? Some people may want to make sure that they have as much money left over when they die to leave their kids, as they had when they retired. Others may be happy for their children to have the house, and there are those who may believe their children to have been well set up during their lives and therefore do not need anything extra. It is important to know that if money is to be left over to leave to anyone, it means that there will need to be more money to start with at retirement.
How much money is needed to live on? Though they may be happy to live on less money when they retire, often people start spending more than they ever did because they are no longer headed to work every day. From a planning perspective, start with a number that is the same as what is needed to spend in the current lifestyle. Filling out a detailed budget questionnaire can help with this, but most people often underestimate how much they spend. Often it is best to simply look at what is earned now, take away how much is used to pay off debts or save and what is left from that is what can be spent.
What rate of return will the money get? Upon retirement, we might like to think that our money has been put into a risk-free environment so that capital cannot be lost, and that makes sense. However risk-free investments pay the lowest rate of return, and as such, will require a lot more capital to fund retirement. For example, with current deposit rates situated at around 2%, $2.5 million would need to be invested to receive $50,000 per annum in interest. However, if there was a share portfolio giving a return of 7%, then only $714,000 would need to be invested to return that same amount per annum. Of course, shares come with a degree of risk, but how much risk are you willing to take?
After considering all the above information, it is possible to mathematically calculate how much capital will be required to pay a particular income for a specific period, and with just how much to have leftover to leave as the inheritance.