When Can You Afford to Retire?

By Bob Moeller
WEAC Member Benefits

February 2002

Financial Planning Seminars
Achieving Financial Independence

When consulting with individual members, many have a single question, “Can I afford to retire?” This is no simple question. Most members can consider retirement with an unreduced pension at about age 57, so the question really is about paying bills 30 years later. How much will everything cost then? How much will my pension cover then? How much will my investments be worth then?

What is a logical approach to figuring out if you can afford to retire? First, you must know the following facts about your current, still-working, financial situation:

• How much do I gross?
  
• How much do I shelter?
  
• How much do I pay in income and Social Security taxes?
  
• How much do I have left to spend?
  
• How much do I spend?
  
• How much do I have left? (presumably invested somehow, such as savings, stocks, etc.)
  

The spending question is sometimes a chore for people. Here’s how I keep track. I write checks for all cash I use. I might use it for gas, or movies, and I know I will never accurately account for it. It is simply “cash expenses” or miscellaneous. I pay bills with checks, and use a charge card for most purchases. Thus, all of my records are on checks or credit cards.

Annually, during Christmas vacation, I use a spreadsheet with about 15 columns labeled the way I spend my money, such as mortgage, car expense, travel, miscellaneous, etc., in the cross columns. On the down lines, I create 12 months with two lines, one for checks and one for credit card. I go through my checks and monthly charge card statements for the year and assign each to one of the columns for each month. I total the checks for each month for each column and enter the number. Any I’m not sure of are miscellaneous. The purpose is to find out how much I spend and where I spent it. I can now construct the following “before” column example: Can I afford to retire? With an accelerated WRS pension estimated at $26,000 per year and a spouse with no pension, how much would I have to invest to afford to retire and pay for increases in the cost of living? If I simply retire on $26,000 a year, the situation will look like the “after” column above. My income taxes will now be based on a lower income and I will save at least a pro-rata amount. In this example the marginal tax rate will also change to 15% vs. 27%, but since I don’t have space to detail deductions, I am going to simply calculate a pro-rata reduction. Of course, if there will be major expenditure changes after retirement, such as health insurance costs, or a mortgage payoff, I will adjust the expenditure number accordingly. Otherwise I will assume my cost of living will stay the same. The question is how much will it take in investments to cover the shortage, plus future inflation?

You can assume that the portion of your expenses covered by your state pensions and Social Security will always be covered by pension, in this case 43.5%, since the pensions should increase by inflation. The balance however will also be subject to inflation and must be covered by your investments. How much more do you need? The next table lets you pick an assumed inflation rate and earnings rate. It assumes 30 years of retirement. I deducted an overall rate of 15% for taxes. This table shows how much you need to cover a $1,000 shortage. A $27,830 shortage means you would multiply your table number by 27.830. As an example, if you assume 3% inflation, and if you assume you’ll earn 6% before 15% overall taxes, you would multiply the shortage, which is 27.83 thousands by $22,732, or 27.83 x $22,732 for a total of $632,632 needed in your investments. For most members, this is a fairly drastic example, so don’t be discouraged from calculating your situation. It will probably look more encouraging.

Amount needed to cover $1,000 a year, plus inflation, for 30 years: Are these calculations perfect? Of course not. Individual differences, such as your spouse getting Social Security in a few years, a mortgage payoff, or health insurance costs, must be factored in. This is intended to get you started!

Posted February 8, 2002