Calculating your retirement needs requires an iterative process of aligning what resources you have with what you need and want in your retirement years. The process is neither simple nor straightforward. You need historical information on spending, good advice based on the experience of others in similar circumstances, and you will need to make reasoned assumptions about the future. However, it is better to calculate for retirement than to find yourself there with no knowledge or plan after you retire.
Step 1
Collect information on your spending over the most recent two- to three-year period.
Step 2
Take the spending data and break it into expense categories. Place the category title and monthly or annual amount on paper or in a spreadsheet. Although pencil and paper work, a spreadsheet makes it easier to change or move information around and calculate subtotals and totals. Choose categories that logically group together. For example, you may have a category called "home expenses" that includes mortgage and insurance, a repair budget, equipment budget, utilities, property taxes and home owner's association dues. Alternatively, you could break up the categories differently, placing all taxes in one category and insurance in another. The objective is to have all expenses accounted for in the spreadsheet.
Step 3
Assign an attribute to each expense type, designating it as "required," "required with control" or "discretionary." For example, your mortgage payment is a required expense. Your electricity is also required, but you have some control over the amount used by implementing strategies or investing in energy-saving appliances and systems. Your vacation is a discretionary expense. Total each expense type.
Step 4
Calculate the total expenses for required spending. Realistically consider what you can make do with in the "required with control" category and add that subtotal to the required expenses category. This total amount is the bottom line of money you need in your retirement, based on historical spending.
Step 5
Talk with your financial advisor, accountant and friends to identify expenses you are likely to have in retirement that you do not have now. For example, most people find that they need additional funding for health insurance and medical expenses. Fidelity Investments reports that a 65-year-old couple retiring in 2008 and living 20 years after retirement will need approximately $225,000 to cover medical costs.
Step 6
Reduce anticipated expenses from their historical average for those items that will logically be less in retirement, such as car expenses if you will be driving less and income taxes if your taxable income is reduced. Include tax breaks offered to seniors on federal, state and local taxes.
Step 7
Adjust expected expenses for inflation. As you calculate forward over several years the money you need for expenses, factor in the effects of inflation by multiplying the total by an additional percentage. According to Bloomberg retirement calculations, "A common measure of inflation in the U.S. is the Consumer Price Index (CPI), which has a long-term average of 3.1% annually, from 1925 through 2008."
Step 8
Collect information on your sources of income. To find out your anticipated Social Security income, look at the expected monthly payment from the individualized form mailed each January or use the online retirement benefits calculator. Other income sources include payouts from IRAs or 401ks, savings, interest payments, dividends, sale of stocks or bonds from qualified accounts, and employer provided pension plans.
Step 9
Subtract the amount you need, adjusted for inflation, from the amount you have available on a monthly or annual basis. If the total available is greater than the expenses, that tells you how much you may have for discretionary spending. If the amount available is less than the amount needed, review your required and "required with control" categories of expenses for items that can be reduced. Alternatively, change the date when you want to begin retirement so that your resources have to cover fewer years or plan to add an income source, such as part-time work, during your early retirement years.
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