Calculate the Effects of Compound
Inflation to better prepare for Retirement
Retirement planning is difficult enough with all
the variables of personal health, stock market
returns, interest rates, Social Security and all the
other contingencies you need to provide for in your
retirement. But in addition to all that, once you
have calculated how much money you will need in
retirement, you find out that because of inflation
the amount you need is like a moving target.
For instance, let's assume that in your planning
you calculate that you will need $50,000 per year to
cover your retirement expenses in today's dollars.
Based on that, you can estimate what you consider a
reasonable rate of return on your investments and
feel relatively comfortable in your plan for
retirement.
Retirement Planning
For instance based on current expenditures lets
assume that you decide you will need $50,000 per
year during your retirement to cover your living
expenses.
Next based on your tolerance for risk you might
estimate that you could expect a 5% rate of return
on your investments during retirement.
With these two numbers you could easily calculate
that you need to have a $1 Million dollar retirement
nest egg to provide an annual retirement income of
$50,000.
($1,000,000 x .05 = $50,000.00).
But your calculations don't stop there. You also
need to plan for the loss of purchasing power of
your money and this
is where the calculations get a bit more difficult.
This is where our Retirement Planning Calculator
comes into play.
Retirement Planning Calculator Example:
In the first field of the Retirement Planning
Calculator, you simply put $50,000 as the Current
Value.
In the second field of the calculator you put the
number of years until you retire let's say 10
years.
In the third calculator field you Estimate what
the Annual Inflation Rate will be over the term
between now and when you retire.
You may estimate
that you expect it to average 4% over the
next 10 years.
Retirement Calculator Example Values:
Current Value: $50,000
# Years until Retirement: 10
Estimated Annual Inf. Rate 4%
When you press the "Calculate Retirement Amount"
button the retirement calculator will provide
two very useful numbers for your retirement
planning.
The first number is the current purchasing power
of your planned retirement income. In other words,
this is how much purchasing power that amount of
money would have today.
So in our retirement example above,
If after careful planning you arranged to have
$50,000 in annual retirement income.
After losses in purchasing power (at 4% per year for
10 years) you would only have the purchasing power
that
$33,778.21 has today.
So even after careful retirement planning without
taking this additional step, you would
still be forced to reduce your lifestyle during
retirement.
The second result given by our Retirement Planning
Calculator is even more useful.
This is the number you would need to have as your
actual retirement income in order to have your
desired retirement lifestyle.
In other words, in the example above, if you
wanted to have the equivalent of $50,000 of current
purchasing power 10 years from now you would actually need
to provide for $74,012.21 in annual income in your
retirement plan. (Depressing isn't it?) but it
is better to know now than to wake up one day unable
to retire when you thought you could.
The Trickiest part of this Retirement Planning
Calculator
Calculating your estimate for the third field may be the trickiest part
of using this calculator. how do you decide what to
use?
You have several choices:
1) Use 3.4% because the average inf. rate
over the long term (from 1913 - 2008) was about
3.4%
2) Use the current Annual Rate (see
Box to the Right)
3) Try several numbers to get a feel for the
difference different numbers make in your
retirement income requirements.
Over the years various decades
have had rates that varied widely from
-1.94% to +8.7%. (see
Inflation by Decade for more details)
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