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I've offerred bits and pieces before of my personalized approach to retirement planning calcuations, as a alternative to the "retirement planner" programs readily found on the web, that I have found too difficult to adjust for my particulars. Since I've been advocating for a goals/assets approach to financial planning, I thought I'd give this another try, more systematically.

The main idea is to project an initial withdrawal rate at retirement, which then allows for assessing how much of a return above inflation you need to get on assets for a sustainable retirement. It is, of course, possible to use more complex goals and plan accordingly: for example someone wanting to leave a legacy could look to an initial withdrawal rate on part of a portfolio to last until actuarial death prediction, with the rest of the portfolio, invested more aggressively, intended for the legacy, but there as a reserve.

It is also important to use a range of inputs for each of the variable. Those who are further from retirement or who are likely to see major changes in expenses or income (e.g., untying the apron string on the kiddies) should expect a wider range of results and less accuracy.

Step 1: Expense projections at retirement

1) Create an accurate annual budget for expenditures, excluding income taxes and wage taxes.

2) Normalize the budget by averaging major expenditures that occur periodically not annually (e.g., occasional expensive vacations, big ticket items, especially vehicles, home improvements, and repairs).

3) Normalize the budget by adding and subtracting items that are likely to be very different after retirement (e.g., mortgage paid off, kids on their own, lower work and communiting costs, downsizing home or cars, increased medical costs, long term care insurance, help with chores, extra travel). Obviously, everyone needs to use a range of estimates on this, with a lot guesswork involved.

4) Project the normalized expenses for a target retirement date or dates after inflation by using a compounding calculator with various inputs for inflation (e.g., compound expenses by 3% for 25 years). I use inflation estimates of 2.5% to 5%, although I have gone as high as 7% to see what happened—not pretty.

5) Add back income taxes. I simply use the current tax tables on the inflation adjusted expenses, plus state tax on the expenses. This is probably too high, because I'm not including deductions or the inflation adjustment for tax brackets. On the other hand, tax rates could go up, and after RMDs kick in at age 70.5, taxable income will be higher (for a while) than expenses, so I figure this is a reasonable gloss for taxes. People who expect income to exceed significantly expenses should probably project income first, then do a tax estimate from that. Others may want to try for a more accurate tax estimate, with deductions and tax table adjustments.

An alternative would be to estimate taxes on current normalized expenses, add them to the expenses, then do the inflation calculations. I've used both and find the results are within the margin of error.

6) The inflation projection of expenses plus taxes will be the amount you will need to withdraw for your first year of retirement.

Step 2: Project Assets

1) Start with current assets. I wouldn't include property for use (home, vacation home) or Social Security at this point, though these can be added in later—investment property should be included.

2) Use a "How Much Will My Savings Be Worth?" calculator, such as TMF's ( with various inputs for amount you can save each year and rate of return to estimate how much you will have by a projected retirement date or dates. (Enter taxes and inflation as zero, because you covered these under expenses). You can do this as a multi-step calcuation if you expect savings (or rate of return) to vary. For example, you might expect to save a certain amount before the kids leave home and another amount after. Or you might expect to reduce your stock assets as you get older, so you would want to lower rate of return estimates. Also, importantly, this treats savings as a constant. Even if your savings rate stays the same as a % of income, savings amount will increase with inflation. Some retirement calculators allow you to adjust for this. With this method, you can use some average savings estimate (it should be less than 50%, because of compounding). Or you can use multi-step calculating, say at 5 year intervals. (I'm sure there is a better way of doing this with spreadsheets, but with less than 10 years to retirement, I just enter in a slightly higher figure than current actual savings for a single calculation. Someone with 30 years to go probably needs to do better.)

3) This range of estimates is the asset number you will use for calcuating an initial withdrawal rate.

Step 3: Initial Withdrawal Rate

1) Divide your inflation and tax adjusted expense estimates by your asset estimates—you should have quite a range. This will provide your Initial Withdrawal Rate. For example, if you expect expenses of $100,000 and you expect assets of $2,000,000, your Initial Withdrawal Rate would be 5%.

2) Adjust expenses and assets for Social Security and use property (home, vacation home). Annual Social Security estimates can be substract from expenses (e.g., $20,000 in SS with $100,000 expenses leaves $80,000 to be covered by assets). Add property to assets, but remember home equity loans or rent/retirement home need to be added to expenses.

3) Calculate Initial Withdrawal Rates with SS/property adjustments.

Step 4: Calculate "Years to Zero" from Initial Withdrawal Rate and Rate of Return/Inflation Estimates.

With a range of estimates, you should be able to decide if you need to try to save more (spend less) or change desired retirement date, and you can return you need, given savings, to reach a desired Initial Withdrawal Rate. If you look at results from different inflation assumptions versus different rate of return assumptions, you can estimate how much of a return above inflation you need to reach your goals. This goes a long way toward helping make goal driven decisions about asset allocation.
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