will receive about $15,000 per year in retirement benefits, with annual expenses of $72,000, they will need at least $57,000 (in today’s dollars; inflation will push that figure higher) per year to help fund their retire- ment, assuming no other sources of income. Once inflation1 is figured in (at a relatively high rate of five percent over 10 years), that $57,000 per year needed turns into $92,853 per year! (Annual expenses after inflation are $117,288.) Neither Jeff nor Mary believes that they will receive any type of retirement pension from their employers. There- fore, they will have to save this money themselves.
$72,000 $72,000 1.629 (5% inflation factor) Annual expenses – Social Security = $72,000 $15,000
= annual expenses = $117,288
= $57,000 (annual shortfall)
= $92,853 per year
$92,853 10% Total needed
= $928,530 = $928,530
Jeff and Mary now know that they have an annual shortfall of nearly $93,000. In order to reach that goal, they will hypothesize their annual rate of return, so that they know how much they need to save on an annual basis. If we estimate a 10-percent annual return on Jeff’s and Mary’s money during retirement, we see that they need to save a total of $928,530 ($92,853 ÷ 10) before they retire in order to be able to live on $72,000 per year in today’s dollars. Continuing with the 10-percent return, their nest egg will yield $92,853 per year to make up their shortfall. Plus, as long as the principal ($928,530) isn’t touched, it will continue to generate this income for Jeff and Mary, and will eventually become part of their estate.
1 Inflation factor found in Personal Financial Planning, Eighth Edition, by Lawrence J. Git- man and Michael D. Joehnk. Harcourt Brace College Publishers, 1999.