Friday, June 17, 2016

How to Make a Successful Retirement Plan

Even for those people who love what they do, retirement is one of those things that constantly stays in the back of everyone's mind. To determine when you'll be ready for retirement, there are a variety of factors that have to be weighed. What percentage of your income can you be comfortable living on? Do you plan to retire completely or try out a new career? These questions and more help to determine how long you would have to work before retiring. Dave Rowan's L.A. Times article sums up some of the major points made by financial planning expert Craig Israelson on the finances behind a successful retirement.

The first topic he mentions is known as the "4% Rule." According to this rule, it is possible to withdraw 4% of one's retirement savings from an investment portfolio each year without ever running out of money. Financial planners set the optimal amount at 4%, but some retirees have to withdraw less, while others who have saved for longer are able to withdraw more without running out. This concept, however, doesn't really help people in their 40s or 50s, who are planning for a retirement in the distant future. For those closer to retirement, the 4% Rule helps because it allows them to determine if they have enough money in savings to combine with other sources of retirement income and have enough money to cover a projected budget.

Israelson has a different method called "RAM" that allows younger people to plan for retirement far down the line. This method involves a lot more mathematical calculations but gives future retirees a way to calculate how financially stable they would be at each age. RAM, or retirement account multiple, calculates the probability that a retiree would never run out of money if they retired at 65, lived to 100, and withdrew half of their final yearly salary (the salary being earned at 65 based on inflation rate of 3%) as an addition to other retirement income like Social Security. Based on Israelson's calculations, a RAM value of 7 or higher means that the retiree is in good shape and will have over 70% likelihood of never running out of money if they live to 100 years old. A RAM value of 18 or higher means that the retiree will never run out of money, no matter how the economy changes.

The RAM is calculated as follows:

First, the retiree's final salary is calculated based on a 3% inflation rate.
Final Salary = Current Salary x (1.03)^(65 - Current Age)

Next, the total amount the retiree will have in savings is calculated based on an average value of 7% as the increase in the value of their retirement portfolio.
Final Retirement Savings = Current Savings x (1.07)^(65 - Current Age)

Finally, the RAM value is calculated using those two values.
Projected RAM = Final Retirement Savings / Final Salary

The more you are able to save now, the better off you will be in the long run. However, it depends on the person. Some people are comfortable with spending money now to enjoy a higher standard of living, even if it means they will have a RAM score closer to 7. Others look for any way to reduce expenditures today in order to get a RAM closer to 18, to ensure that they won't have to worry about their future finances. Additionally, the previous RAM calculations didn't include additions to the retirement portfolio. If someone were to continuously save and invest more money toward retirement, they would find their RAM value increasing, based on the following calculation:
Extra Retirement Savings = [(Current Salary + Final Salary) / 2] x (Savings Rate) x (65 - Current Age)

Of course, these calculations aren't perfect, since the economy is constantly fluctuating and many assumptions have to be made about future income and changes in saving patterns. However, it should be able to give savers a good look at how well off they will be in their retired years. The RAM is simply an approximation method, not an exact science, but it should give people a sense of whether they will retire successfully and how long they may have to wait to do so. 

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