Planning for retirement can be a scary process because it requires a tremendous amount of money that may never be enough. You may be unsure about how much your costs will be, how long you will live and how much extra income you will have. Of course, you may also want to leave behind some funds for your heirs and perhaps some important causes that you believe in. In the end, the most important question is how long will your portfolio last in retirement? Fortunately, new research is starting to shed light onto the answer and helping many seniors get a better handle on their finances.
According to Moshe Milevsky, a statistics and finance professor at York University in Toronto, there is a formula to actually calculate how long your funds will last into retirement. While the formula requires some assumptions, it provides a clear way to forecast into retirement so that seniors can be more assured of their financial security.
Professor Milevsky's formula looks complicated at first but is fairly easy to use with just three inputs from your finances. The formula is as follows:
EL =(1/g) ln((w/M)/((w/M)-g))
EL stands for Estimated Longevity and is the amount of time that the funds will support you (in years).
g is the growth rate of your savings, expressed as a percentage. This is the most difficult assumption and needs several different adjustments. It is a "net" number after deducting for investment costs, inflation, taxes on the withdrawals, etc. It is also directly related to the allocation of your assets. A lower allocation to growth assets, like stocks, will necessarily bring our beginning number down. For example, you may have a typical 60/40 balanced portfolio with an expected return of 6%. The net number to use in this equation will be: 6% minus investment fees minus inflation and a tax assumption. For many people, investment management fees are 1-1.5%, and we may want to use a historical inflation estimate of 3.5%, so 6%-1%-3.5% = 1.5%. If you pay 20% income tax on your withdrawals, you are now closer to 1.2% That's your "g".
w is the annual withdrawals that you will make while on retirement in actual dollars. You will need to assume your rent, your medical expenses for drugs or procedures that are not covered by Medicare, daily living costs as well as travel and leisure. Depending on your lifestyle, the withdrawals could be minimal or a very large number. Of course, if you are receiving pension payments or social security payments you can immediately put those funds towards your withdrawal amounts.
M is the total savings that you have today and will place into the dedicated retirement account. The larger this number the better. So if you have $50,000 in retirement funds today, you will most likely need to add more. If you have several million, you could be on the road to an easy retirement.
ln is an operation that means the natural logarithm of the number. Due to the fact that the spending and income occur over time, the logarithm operator is required to discount the value of those funds to the present day number.
Let's take a simple example to understand the savings and growth you will need. If the growth rate g is 2%, the savings M is $1,000,000 and the withdrawal is $60,000 per year. Using these values, the EL is 20.3 years, so if you retire at 70 you will have enough funds for a typical life span. Modifying the values provides a greater or smaller EL.
Additionally, we've created a quick calculation tool if you'd like to try this out yourself without building your own spreadsheet (as we did). You can try it here:
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