How much money are we going to need for a happy retirement?
The math is done from the end to the beginning: how much we’re going to need in retirement to how are we going to get there how many years in retirement?
We count the years of the life in retirement from the date of retirement up to the expected life
How much do we spend during retirement?
What incomes do we have when we retire?
We should use saving and income retirement apps or calculators because they are a very useful money management tool
How much money are we going to need for a happy retirement?
After a lifetime of hard work what we want most is to enjoy a good retirement. Our children have left home and are building their own lives. At this stage of our lives we have finally time and availability for doing what you’ve always dreamed of.
Our goals are simple:
- Make sure that the money we have is sufficient to maintain our standard of living;
- We live with the best possible health care;
- We perform a few trips we always dreamed of, to learn about other worlds, visiting family or friends, to venture into the unknown, living new experiences etc.
How can we know the money we need?
The math is done from the end to the beginning: how much we’re going to need in retirement to how are we going to get there how many years in retirement?
The answer is simple. It is the same math we do on a daily basis today, income and expenses, with the only difference that are designed for the future. Though, this is a big difference, as the certainty of the present doesn’t match the uncertainties of the future.
We must start by calculating how much we spend, which is nothing more than the value of the estimated annual expenditures multiplied by the number of years in retirement. We must estimate the predictable income we will have in retirement, from social or public pensions, private pensions of employers or of joint contribution and other expected income. The difference between expenses and incomes tells us which additional personal income we must have to live comfortably. This income can only come from the wealth chest we are accumulating specifically for retirement.
We count the years of the life in retirement from the date of retirement up to the expected life
Once again, we start backwards: how many years will we expect to live in retirement? Hopefully, many. Pensioners must prepare for a long life in retirement. At 65 years old, our average life expectancy ranges between 24 and 18 years, for women and men, respectively, in the main OECD countries.
The increase in life expectancy has been tremendous over the past few years. On the other hand, the official retirement age, as well as the effective, has not varied much. This way, the greater longevity brings more years in retirement.
The following chart shows the evolution of life expectancy for some of the most advanced economies in the world, between 1960 and 2015, and the best projection for 2050. In 1960, the average number of years in retirement ranged between 6 to 8 years Between 1960 and 2015 there has been an increase to this number of 5 to 16 years more (in Japan), so, now, we live in a total of 14 to 24 years in retirement. It’s all about a second youth that we need to finance.
Source: We’ll Live to 100: How Can We Afford It? World Economic Forum, May 2017
How much do we spend during retirement?
Many times it is thought that our costs will fall dramatically in retirement. You don’t have to bear the huge costs of the mortgage, we don’t need to spend with our children because they already are independent, we lower our food and transport costs because we eat and stay more at home, etc. However, we forget that there is another set of expenses that also grows: spending on health care in old age, but also of the trips that we always wanted to do, we want to continue to give support to our children families, etc.
Studies show that the expenses in retirement are 85% of previous spending on average. If we take into account these spending reductions, the smaller savings needs and lower taxation of pensions, it is estimated that, in retirement, we’re going to need about 75% of the money we needed before to maintain the same standard of living.
What incomes do we have when we retire?
We are entitled to social pensions and private pensions made with employers.
The public pensions amounts from social protection schemes, as a percentage of the working income before retirement and tax-adjusted, also called net replacement rate, represent more than 90% in Portugal, 60% for the OECD countries, almost 65% in the European Union, about 45% in the United States, and less than 30% in the United Kingdom.
Source: Pensions at a Glance, 2017, OECD
https://www.oecd.org/daf/fin/private-pensions/Pension-Markets-in-Focus-2021.pdf
However, to make up a full picture, we must add the private public pensions in countries in which this scheme is mandatory, as is the case of the United Kingdom, as well as in others in which it is voluntary, as the United States.
Occupational transfers are a private personal pension scheme with portability. They are a very relevant income source for people aged 65 years or more in countries like the Netherlands, United Kingdom, some Nordic countries, Switzerland, Australia and the USA, as they are an important complement to public pensions. In addition to these there are also private pensions made by employers or in association with these, which add up as another income source, and are a very important component of the income of the retirees’ population in countries such as Canada, Australia and the New Zealand.
Finally, we must also take into account the income from work for those who keep working beyond 65 years of age. We conclude that the countries in which the senior work is more relevant are South Korea, Mexico, Canada, New Zealand, USA and Chile Japan, contributing to more than 20% to the total income.
It is from the difference between the public, private pension income and other income sources, and expected expenses, in retirement, that we get our budget for life in retirement. The difference between spending and those incomes must be covered by money coming from the personal retirement fund, or from the capital and earned returns. In other words, everything left to cover expenses that we will have in retirement will need to be complemented with a personal savings and investment plan. It is this piggy bank or personal retirement fund that it’s only up to us to create and make grow.
How to feed make it grow in terms of savings, and how to manage their investments, will be developed in another post.
We should use saving and income retirement apps or calculators because they are a very useful money management tool
To estimate the amount that we will need in retirement and see how we can get there, it is very useful to use good calculators, simulators or retirement apps. Two of the best international simulators, because they are simple and complete, are the ones of Vanguard and Bankrate, which can be accessed through the following links:
https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementIncomeCalc.jsf
https://www.bankrate.com/calculators/retirement/retirement-plan-income-calculator.aspx
In the Tools section we explain a little more how they can be used. Given their importance and utility we’ll also delve into this subject in another post.
