Must do Homework!

Michael Ford of the Palm Beach Letter (highly recommended) recently covered figuring out your magic number for retirement.  Aunty likes to live comfortably – but it doesn’t just happen.  Most people fall into 2 categories when it comes to figuring out their retirement needs:  1) procrastinators – those that put off or don’t really want to face what will be, and 2) pluckers – those that just pluck numbers out of thin air, making guesses.  Aunty admits to being a plucker AND a procrastinator, but has since learned to do her homework.

Want to know your magic number? – that target figure that you will need to have in order to retire the way that you would like?   This is the dollar figure of your investment/retirement account that will generate enough to replace your active (paycheck)  income and pay for your expenses, continuously.  Here are the rather simple steps:

Step 1 – Find your Lifestyle Burn Rate (LBR)

This is easy to do – calculate how much you are spending right now to live each year.  [Aunty has Quickbooks “companies” for her business/investments as well as one for personal accounts.  Quickbooks takes time to learn and input, but once done, it is SO convenient for accounting, taxes, and these kind of reports.]

It is easier if you group expenses into 3 basic categories: housing (mortgage, maintenance, taxes), basic living (food, clothing, health expenses), and entertainment (includes travel).  Charity and education could also be 2 additional categories if you have expenses in those areas.

Add up all your expenses for each of these for the entire year (use last year’s figures) – this total will be your current Lifetime Burn Rate.  Do not guess.  You want to have real numbers that are true for you.  You may also be surprised at what your number(s) look like.

If you are still young and without dependents, you have a low Lifestyle Burn Rate (stage 1).  Your LBR dramatically rises after you have your first child, buy a house, pay for their education (stage 2).  Then, after the kids leave the nest (stage 3), your LBR will be at least twice what it was when you were younger and carefree, but not as much as stage 2.  If you are in stage 1 of your financial life, calculate your current LBR, and estimate for your future stages. 

Step 2 – Adjust your LBR (Lifestyle Burn Rate) with extras or deductions

To reach your Retirement Lifestyle Burn Rate (RLBR), add in those extras that you want, i.e. weekly massages, more travel, gifts to grandchildren, golf club expenses.   Then, subtract those expenses that you currently have but do not plan on having when you are retired.  These expenses could be mortgage payments if you pay off the loan in entirety by the time you retire, less education expenses if you are still paying for your child’s college, less housing payments if you downsize.

This new number, your Retirement Lifestyle number may be larger, or smaller than your current Burn Rate.

Step 3 – Adjust your RLBR (Retirement Lifestyle Burn Rate) if you have any additional sources of income

These additional sources of income could include retirement pension payments, Social Security, part time work that you plan to do, etc.  Whatever these add up to, slash the number in half (i.e. if Social Security, pension, and part time work is predicted to be $30,000 per year, divide by 2, leaving you $15,000).

After subtracting your anticipated additional sources of income from your RLBR, you will now have your Net Retirement Lifestyle Burn Rate (NRLBR).  This number is a very important number.  This is the dollar figure that you will need every year to live the lifestyle that you want when you retire.

Step 4 – What rate of return will you be getting on your savings/investments?

Hopefully you have savings or investments that generate income for you.  If you do not, start today and build up your savings and investment portfolio.  [This is the reason why Aunty took RichDad classes – even without doing this exercise of LBR, RLBR, NRLBR.  Aunty knew we were in trouble, and that we needed to generate passive income for our retirement needs.  One of the best ways, in Aunty’s opinion, is tax free with a Roth IRA.  Even better is with a checkbook Roth IRA that controls real estate, short or long term capital gains, note lending, etc.]

Calculate what you currently make on your current available funds/portfolio.  Then figure out the after tax total.  This after tax net income divided into the portfolio total value is your current rate of return on your investments/savings.   This number might be as low as .5% (YIKES!) if you have all your money in a bank savings account.  Hopefully it is much higher, with dividends from stocks paying at least 3%, real estate rental income paying out 10%, income from other investment vehicles such as notes, bonds, etc.

Be very realistic with this.  Do not make up a percentage based on what you wish you had.

Step 5 – Calculate your Magic Number

Take your NRLBR (net retirement lifestyle burn rate) that you got from Step 3 and divide it by your expected rate of return (from Step 4).

THIS is your Magic Number!  This is the amount you need in your investment/savings/portfolio.  How does it look?

If you have a lot of retirement income from your pension plan – i.e. a retired Hawaii State worker, you are in pretty good shape.  However, it might still be a good idea to have additional income from investments, don’tcha think?