Retirement Planning (Part 2)

Answer 1

In my last post I talked about beginning to plan for retirement. Now let’s talk numbers. Once you approximate your gross annual income needs at retirement you have a place to start doing some math that’ll help you plan. We will be doing “time value of money” calculations. If you’re unfamiliar with the concept, Wikipedia has a great introduction.

So the key here is to remember that we want to figure out how much money you’ll need in order to draw an annual income from in retirement. So two important things to consider are when will you retire and when will you die. I know, death is never fun to talk about, but you do need to think about it if you want to plan to have money for the rest of your life.

So once you figure out the annual draw on your retirement funds you’ll need to live off (your retirement income stream), you’ll need to do some tweaking to calculate the present value (PV) of it at the time of retirement taking into account all inflation and cost-of-living adjustments, maintaining the equivalent annual amount as an income stream. If you have a financial calculator you can do this by using the income stream as the PMT value, your inflation and cost-of-living factor as the I%, the number of years as the number of periods, or N value. Then use the financial functions to calculate the PV. If you do not have a financial calculator you can use Excel or other spreadsheet program or you can use this formula from the Wikipedia entry on time value of money:

Use your annual income needs as A, an inflation rate as I, and the number of years as n. This will give you the pot of money you’ll need to accumulate by retirement.

In future posts we’ll talk about how you can go about planning to amass this pot of money and protect it until that retirement party. In the meantime, don’t get discouraged by big numbers, especially if you’re far away from retirement. This time value of money thing can work to your advantage too. More on that in future posts.