In a couple of posts, I have talked about The Number – the amount that you need to have saved (preferably, invested in passive income-producing investments) by the time you retire.
Before we move on, it’s probably time for a quick review of what I mean by ‘retirement date’ because it’s not the same age-related date as most Personal Finance books and blogs assume:
‘Retirement Date’ = The Date YOU Choose to Stop Work!
… This is not 65 or any other age your boss, the government, or society tells you! If you are 35 years old and actually want to retire @ 65 on $1,000,000 a year this is NOT the blog for you!
Now, having got that one off my chest (!), one of my readers, who IS close to the traditional retirement age, asks a great question about how to figure his retirement benefits (which, he will receive as an annuity rather than a lump sum) into The Number for him …
… you can read his original comments here, but this is the essence of his problem:
I am just having trouble trying to quantify my pension so I can include it in my net worth … the trouble is I don’t receive a lump sum, but rather 65% of my base upon retirement, every year, which includes increases for cost of living every year.
The problem is that this reader was trying to find a way to calculate the ‘implied passive asset value’ of this pension into his Net Worth … while you could do that, there’s no real reason to.
If you are in a similar situation, what you really need to know is:
Can I live my ideal retirement on this pension … if not how much extra do I need to count on having in investments by the time I do want to retire?
To do that, we only need to make a slight modification to the formula we have used before.
1. STATE how much you need to live your ‘ideal retirement‘ assuming that you stopped work today (it’s not how much you would have, but how much you would need). What is that number?
2. DOUBLE that amount for every twenty years that you have left until retirement (add 50% if only 10 years, etc.). What is that number?
3. SUBTRACTthe annual value of any social security, annuities, pensions, or other regular amounts that you are reasonably (actually, very) certain to get. What is that number?
4. MULTIPLY your answer by 20 (slightly conservative) to 40 (very conservative). That is The Number … for you!
A couple of points:
I usually ignore Social Security and other government benefits, mainly because governments and regulations change … the longer until your chosen ‘retirement’ the more chance that these things will vaporize before you get there.
Similarly, I work on pre-tax numbers, because I have no idea what the tax regulations will be like …. the longer you have to wait until your chosen ‘retirement date’ the more chance that taxes will change (read: increase) before you get there.
But, these are only rough calcs to get you aiming towards a (probably) larger target than you previously figured on … as you get closer to your planned retirement, you will no doubt have had a number of sessions with a suitably qualified financial adviser who will figure out the exact effects of things like: inflation, taxes, social security.
Now, if you are still a fair way away from retirement (say 10+ years) you may want to figure in the impact of the pension on your Investment Net Worth.
You could multiply your expected yearly retirement benefit, again assuming that you were retiring today, by 20 (this time using the lower number means that you are being extra-conservative) and add this figure to your assumed Investment Net Worth.
You could do these things … but, I wouldn’t.
How certain can you be that you will qualify for any of these things in 10+ years?
What happens if you can’t work, get laid off, your company goes broke or it can’t meet it’s obligations, or … ?
The reason for these ‘rules’ is to ensure that you put your foot on the investment gas … now … and, hard!
Don’t use possible future company or government benefits as an excuse to over-spend and under-invest!
By the time you do retire, you’ll be glad that you didn’t …