By Alvin T. Tabañag, RFP®
If you ask a group of 20 people how much money they need to have a comfortable retirement, you will probably get 20 different answers. The amount can range from P1 million to hundreds of millions. And most of the figures are just “guesstimates” which don’t have any sound basis.
Based on what I’ve gathered from participants of my seminars, only about 30% of Filipinos have a fairly accurate idea of how much they need for their retirement. Many come up with unrealistic figures that are either too low (e.g. P1 million) or exceedingly high (e.g. P100 million or more). A few fantasize about having a billion for their retirement.
It is important to have an accurate estimate of how much funds you need so you can prepare properly and adequately for your retirement. “Guesstimates” just won’t cut it. Guess too low and you will find yourself among the 90% of senior citizens who are either living in poverty or just getting by. Guess too high and you could spend the rest of your working years constantly under stress, desperately trying to reach a goal that’s practically impossible to achieve.
There are a few quick and painless ways to determine your retirement needs. One popular method assumes that you will need 70 to 80 percent of your pre-retirement income to maintain your standard of living when you’re retired. So if your projected annual income shortly before you retire is P1 million, then you need to have a yearly retirement income of P700,000 to P800,000. A variation of this approach is to use as basis your pre-retirement expense instead of income.
Another quick method is the Rule of 25, where you project your annual retirement income need and then multiply it by 25. For example, if you require P1 million every year after you permanently hang your work clothes, then you should accumulate a retirement fund of P25 million (P1 million x 25). Too big, you say? You’re right.
This method overestimates the required retirement fund. You can vary this rule slightly by using 20 as the multiplier. The resulting estimated retirement fund will still last for more than 20 years.
Calculating More Accurately
It is essential that you have a very good estimate of the amount you need to retire comfortably so you can come up with an effective and realistic retirement savings plan. The steps required are a little more tedious than the quick methods above. But you have to strive to understand and follow these steps if you want to prepare adequately for your golden years. You will need a financial calculator or Excel to do the calculations. The functions used in the calculations are PV (present value), FV (future value) and PMT (constant payment over a certain period). Here are the steps.
1. Calculate the Number of Years Before Your Retirement
Simply subtract your current age from your target retirement age. For our sample calculation, use 35 as your current age and 60 as the age of retirement.
2. Estimate Your Expenses As If You Are Retired Today
Use your current budget as reference. (Create a list of your current expenses if you don’t have a budget.) A number of your expenses may increase, decrease or disappear when you go into retirement. For example, expenses for travel and vacation will definitely increase, while expenses for utilities will likely decrease since your children will no longer be living with you. Education-related expenses will no longer apply when you’re retired. Adjust expense items accordingly. The result will be your retirement budget expressed in today’s money. Let’s assume that it’s P50,000 a month.
3. Adjust Estimated Expenses for Inflation
Adjust for inflation the amount determined in step 2 to calculate the future value (the year you retire) of your retirement expenses. Assuming an inflation rate of 3%, the value of P50,000 when you retire 25 years from now is P104,689 [=FV(0.03, 25,, -50000)]. (Don’t mind the negative sign. It’s put there so that the answer comes out a positive number.)
4. Determine Other Sources of Retirement Income
Your retirement income will not come entirely from your savings. There will be other sources, like your government pension and income from part-time work you may want to pursue. Assume that your monthly SSS pension is P10,000 and you earn an additional P15,000 per month from part-time work for a total monthly income of P25,000.
5. Calculate Retirement Income Gap
Subtract the amount in Step 4 from the amount in Step 3. This gives you the retirement income gap which you need to fill from your savings. In our example, the monthly gap is P79,689 (P104,689 – P25,000) or P956,268 yearly.
6. Calculate Retirement Fund Needed to Cover Income Gap
This is the amount of money you need to have in order to generate the required income in Step 5. To calculate this, project how long you will live in retirement. Assume 20 years or until the age of 80. You also need to estimate the rate of return or the interest rate of your retirement fund. (Unless you put all your savings under the bed, it will continue to earn interest throughout your retirement.) Assume that the rate of return is 5%. The retirement fund needed to cover the income gap is P15,636,352 [=PV(.05-.03, 20, – 956,268)]. .03 or 3% is the inflation rate.
7. Estimate Retirement Lump Sum Benefit
You don’t need to save for the full amount in Step 6 since you will likely receive a lump sum benefit when you retire. Assume that you will get P2 million in retirement benefits.
8. Calculate Retirement Fund Gap
Deduct the amount in Step 7 from the figure in Step 6. In our example the retirement fund gap will be P13,636,352 (P15,636,352 – P2,000,000). This is the target fund you will save for from age 35 until you retire at age 60. You will be able to live comfortably if you have this sum when you retire.
9. Calculate Required Savings to Accumulate Target Fund
You need an estimate of the rate of return of your money during the saving period (age 35-60) to do this calculation. Assume it is 8%. (Note that this is higher than the rate in Step 6. Retirement money is supposed to be placed in a safer place when you are already retired, hence, the lower rate.) The required annual savings in our example will amount to P186,528 [=PMT(.08,25,,- 13,636,352)] or P15,544 monthly.
There you go. Just go over it again if you are confused. It’s not really as difficult as it looks. However, if you still feel like you’re getting a nosebleed from following the steps, use a retirement fund calculator instead. You can use my calculator at www.pinoysmartsavers.com/psscalculator.xls. It gives a more accurate answer because it takes into account a few other factors not considered in the steps above like an increasing rather than constant retirement expense. Whether you follow the steps here or use a calculator, just make sure you do the numbers. Because that’s the only way you can accurately determine your retirement needs.