“More men are killed by overwork than the importance of this world justifies.”
“The best time to start thinking about your retirement is before the boss does.”
All too often, people plan for their retirements using a vague notion of some time in the future and some system that will take care of them. They plan to work until age 65 and hope that Social Security or a pension will take care of their needs. What happens, though, when we take a point in time, such as age 65, and start working backwards? In the financial planning process, we typically figure out how much income you’ll need at a given retirement age, account for inflation, since a dollar today won’t buy as much in the future, estimate an earnings rate on investments, and calculate how much you’ll need to save to get to a point where you’ll have enough money to provide your needed income.
Let’s take a hypothetical example. Say Bob is 45 years old, has $250,000 saved, and wants to retire at the end of the year that he turns age 65 and will need $50,000 a year in today’s dollars. He expects to get $20,000 in Social Security and anticipates living to age 90. Since Social Security is indexed to inflation, he’ll need $30,000 a year in today’s dollars to maintain the expected standard of living, and he wants to leave $200,000 in his estate. For simplicity’s sake, let’s assume a constant 3% inflation rate and that his investments earn 5%.
In 20 years, because of inflation, he’ll need his investments to provide $54,183.34 a year – that’s the equivalent of $30,000 in today’s dollars. Then, he’ll spend down and, assumedly, not add more to his investments. Therefore, to hit his target, he’ll need to save $13,273.68 until he reaches age 65.
But what if he wants to retire at age 64?
He’ll need his investments to provide, at that time, $52,605.18 and last him for 26 years, not 25 years. He’ll need to save $15,269.91 per year, or $2,023.23 more per year.
Choosing to save $168.60 a month more will allow Bob to retire a year earlier. That’s one nice meal a week or cutting out cable and a nice meal a month. There are some choices that Bob can make to cut back a small amount now to gain a year of retirement later.
Let’s change the variables for Bob. Let’s make him 25 years old with no money saved up. He has no kids but wants to leave $1 million to his favorite charity. He’ll need to save $17,494.68 a year to be able to retire at age 65 with the same standard of living as before. What if he wants to retire at age 64? He’ll need to save $18,418.68. In annual terms, that’s an additional $924.01 and in monthly terms, it’s an additional $77.
The pattern is not linear. For each year that Bob wants to retire earlier, he’ll have to save incrementally more. However, the jumps per month are not enormous. Note, each increase is additive, so, for example, to retire at age 63, Bob must save $157.25/month more than the baseline retirement year of age 65: $77.00 a month more to retire at age 64 plus an incremental $80.25 a month.
Monthly Increase in Savings
While the amount you will need to save is specific to your situation, it is worth realizing that the amount of increased savings needed to retire a year earlier, particularly if you are young, is not a vast amount. In the case of a young Bob with no savings and investments barely beating inflation, eliminating a car payment and instead saving that money could probably buy him 3 to 4 years of early retirement. Making coffee at home (average cost of $.50 a cup) versus buying at Starbucks (average cost of $3 a cup) would buy a year of retirement.
Some splurges may be worth it. If you reduce your life down to such a barebones existence that you are perpetually miserable, then not working while still living like Silas Marner likely will be a pyrrhic victory at best. However, if it’s an indulgence which provides no long-term lasting value (really…will you notice the quality of coffee THAT much?), then perhaps it’s time to rethink whether or not the spending now will be worth the extra work later.