Oran Hall | Counting your nest egg - How much is enough for retirement?
QUESTION: I have recently started to really take a look into my finances and to think about retirement. Doing my research, I often see where in the United States, US$1 million is often the figure recommended to have for retirement or at least 25 years' expenses. However, when it comes to Jamaica, I am still a bit unsure with our ever-fluctuating dollar value. I am 28 years old, single, and have no children. I earn about $100,000 per month and have monthly expenses of $50,000, but saving and investing to earn US$1 million by retirement age seems a bit of a daunting task.
What would your advice be on a number for retirement? I also have the goal of early retirement.
FINANCIAL ADVISER: You do not have to accumulate US$1 million for retirement. I wonder how many Americans that figure applies to and why you should be guided by a figure that has nothing to do with Jamaica.
Your expected lifestyle in retirement is what ultimately determines how much it will cost and how much you need to have to live at the level you want. A general rule of thumb is that it takes 80 per cent of pre-retirement income to fund life in retirement, but it takes less for some persons and far more for others.
A major challenge in determining the size of the nest egg required for retirement is that the future is so uncertain even in the short term.
Among the variables to be considered in doing a retirement income calculation as the basis for determining how much is needed for retirement are life expectancy, intended retirement age, intended retirement lifestyle, future inflation rates, tax rates, the asset mix between now and retirement, rates of return, benefits expected from government, company pension benefits, and estate planning goals.
None of the above can be known with any certainty, making it necessary to evaluate the plan to fund retirement every two or three years. The greater the guaranteed income streams in the projections - government benefits, annuities, and company pensions - the more certain the income projection.
Establishing the size of your pension next egg is thus an ongoing exercise as changes should be made to reflect the new realities that emerge from developments in the economy, financial markets, and your personal and financial circumstances.
As you move towards retirement, your plan for it should include a budget consistent with your anticipated lifestyle using current income and expenditure as a guide. But much can change by the time you retire. Health challenges, for example, often cause retirement finances to go off-track, considering their cost and unpredictability.
When you do your retirement-income calculation, you are likely to find a shortfall between the required income and what your programme will generate. In such a case, it will become necessary to make a plan to close the gap. It could mean saving more, investing more, investing to make higher returns by investing to earn more tax-free income or taking more risk, for example, or lowering the expected quality of life in retirement thus reducing the required retirement, income and, consequently, the pool of funds required to generate that income.
Opting to retire early is not a matter to be taken lightly. Of course, some persons do continue to earn employment income after formally retiring, thus making it possible to live at a respectable level in retirement.
Early retirement generally means lower retirement income even if the retiree benefits from a formal employer-sponsored pension arrangement. Here are some of the reasons.
In the case of the defined contribution scheme, the employer and employee have fewer years in which to contribute to the pension scheme, thus limiting the pool of pension funds, and there is less time for the contributions to earn income and thus increase the pool of funds.
There are fewer years on which to base the pension benefit in the case of a defined benefit pension plan, and the pension has to be paid over a longer period of time regardless of the type of pension arrangement.
It is good that you are young. If you start saving and investing now, you could conceivably accumulate a healthy pool of retirement funds such that you could even reduce the level of your savings and investments in later years.
Your position should be even better if you have a guaranteed source of retirement income such as an employer-sponsored pension or a pension from an approved retirement scheme, and, although small, contributors of the National Insurance Scheme can expect some benefits when they retire.
- Oran A. Hall, the principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. email@example.com