I have mentioned a couple of times in recent posts that I would talk about how I calculate my retirement nest egg, well today is the day. It was probably about 5 years ago, that I wanted to seriously analyze my retirement savings. I had some decisions to make and needed to figure out what my retirement savings would look like in 30+ years. I tried looking at various on-line calculators, but found myself disappointed in them. Essentially, the calculators weren’t robust enough for me. I couldn’t change some basic assumptions that were built into them. So, I built my own. It is not overly complicated. It is simply an Excel spreadsheet that projects out for about 30+ years. I’ll talk about the things I put into it and the variables that I changed over time.
The first thing you would need to look at his what retirement benefits does your employer offer. For me, the company provides a matching contribution to the 401k, along with a fixed percentage of salary contribution regardless of whether I contribute or not. The assumption I made was that the plan would remain the same throughout my working career. Not very realistic, but it would be too hard to guess what the changes would be in the future. Also take note when looking at your plan, is what compensation is included in the employer match? Is it against base salary only? Are bonuses and overtime considered?
The next assumption I made was related to my salary. How did I think it would change over time? I wanted to be a little conservative, but also have faith in my ability to grow my earnings. Here I decided to grow my salary at 4% every year from its current level. I felt this was reasonable given my track record since I graduated college. I have managed a 6% average annual growth over the last 15 years.
The next decision I made was how my contributions would change over time. This was the biggest drawback I felt to the on-line calculators. I wanted to increase my savings over time. For me, I wanted to assume that I would increase my savings by 1% of my salary every year. The thinking is that when I receive a raise, I can raise my savings rate and not notice a decrease in my take-home pay.
This is perhaps the biggest unknown. I assumed an average return of 9%. Some will argue that is overly aggressive, but I am comfortable with it. I feel like over the course of 30 years, I should be able to generate that level of return.
Here is another assumption that can have a huge impact. When I calculate what my savings will be in 30 years, what I need to know is will that be enough? I translate the future amount back into present dollars via the inflation factor. I used 3% as my assumption. That has been the historical rate of inflation and I felt it was a reasonable assumption.
Do I have enough?
In the end, trying to figure out if I have enough is just a guess. The bottom-line I looked at was would my savings be enough to generate an income equal to my take-home pay when I retire. I assumed a 4% withdrawal rate. I figure if I am living off my take-home pay just before retirement, then that amount should be adequate to retire on. As I get closer to retirement, I’ll have a better idea of what my spending will actually look like.
Have you calculated your retirement number?