In this article, we’ll determine how much you need to save each month in order to adequately fund your retirement.

The first task in planning for retirement is to determine how much money you will need to live comfortably in retirement. To accomplish this, we’ll use the Time Value of Money calculator that I posted earlier.

First, determine how much you want to draw each year out of your retirement savings. Personally, I believe that my wife and I would be very comfortable on $60,000 annually in retirement. Your number may be higher or lower, but we can use mine for an example.

How long do you have until retirement? If we consider that you can draw out of your Roth IRA with no penalty after age 59.5, that gives us quarterlifers about 35 years before retirement. Assuming 4% inflation , I will need $236,765 per year in future dollars to have the same lifestyle in retirement that $60,000 would buy today.

To find find this number for yourself, put the following values into the TVM calculator:

PV = 60,000, or anticipated annual need
PMT = 0
r = 4%
m = 1
t = 35

Hit “compute” next to FV and voila! There is the annual payment amount that you will need from your retirement savings, adjusted for inflation.

Now, determine how many withdrawals you will make - in other words, for how many years you will be retired before you die. As an American, your chances of making it to 80 years old are pretty good. I do not want to run out of money, and I believe that there is a strong possibility that many of our generation will push 90 years old. So to be conservative, let’s use a life expectancy of 90. That gives us 30.5 golden years of blissful retirement.

Now, do you want to leave something for the kids, or draw your accounts down to nothing? We will assume for now that you want to spend every penny of your retirement savings during your lifetime, which makes the future value of your retirement accounts at zero.

We will assume that our retirement portfolio matches the S&P’s historical returns at 10%.

Now, plug these numbers into the TVM calculator to determine exactly how many dollars you will need on the day you retire in order to adequately fund the rest of your retirement. You can tweak the numbers however you like to be more conservative or more aggressive.

In my case:

FV = 0
PMT = -236765 (neg. as it is considered withdrawal)
r = 10%
m = 1
t = 30.5

Solving for PV gives a sum of $2,238,277 - our retirement savings target!

I know that seems like an impossible figure to reach, but bear with me. You have 35 years to save - which gives your savings enormous power to grow. Now let’s determine how much you need to save every month to reach that goal: back to the TVM calculator.

Now, take your retirement savings target and plug it in (as a negative) for FV. PV is the total of your retirement accounts right now….we’ll assume zero. Let’s keep the rate of return at 10%, assume 12 payments per month, and time of 35 years.

Solving for PMT gives us the value of $589.54 - the combined amount that my wife and I must save each month until age 59.5 to retire comfortably, given the assumptions we’ve made about rates of return and inflation.

Conveniently, each individual is permitted to save up to $4,000 per year (or $333.33 per month) in a Roth IRA. A couple, like my wife and I, can sock away $666.66 each month and max our our Roth IRA - oddly close to our actual need of $589.54 per month. If you are single, and plan for $30,000 per year in today’s dollars for retirement, the same calculations dictate that you save $294.77 per month. Max out your Roth IRA at $333.33 per month and you will be in good shape!

How to split the savings between 401(k) and Roth IRA: Take advantage of the full company match in your 401(k), if available - and put whatever else you are able into your Roth IRA. If you are able to save more now, go for it!

I implore you to consider the monthly figure that you have just determined as a “minimum payment” to your retirement savings. Have that amount drawn monthly from your paychecks or checking account into your 401(k) or Roth IRA. Never skip a payment. You can afford it; make the payment for six months and you will notice that your spending habits adjust without a noticeable impact to your lifestyle.

Action Items:

1. Use the time value of money calculator to determine the amount that you need to save each month to adequately fund your retirement. If you are not willing to go to the trouble, just plan to max out your Roth IRA each year ($4,000 per year or $333.33 per month).
2. Set up an automatic draft into your retirement accounts from either your paycheck or checking account, in that amount.

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This entry was posted on Monday, September 25th, 2006 at 10:00 am and is filed under "The Plan", Retirement, Roth IRA, Saving. You may e-mail this post to a friend. You may print this page. You can leave a response, or trackback from your own site.