Retirement can be a rewarding phase in a person’s life, which is why so many people want to retire early. Some plan to work until they are 45 years old, and thereafter to spend the rest of their lives on the beach, or traveling round the world. Of course, the ability to retire early would depend on how much money you can successfully set aside (during your working years) – and this would normally depend on how well you have planned for your retirement.
It is important to engage in basic retirement planning throughout your working life and update those plans periodically, especially when your situation change – financially or otherwise. While it is never too late to plan for retirement, starting early helps to avoid any unnecessary stress. In order to save for the future, there is of course that trade-off between spending and saving. For example, if you spend lavishly now, buying expensive sports cars, high-end hi-fi systems or overseas holidays, then you may not have much left in your bank account when you retire. Unless of course, you have managed to set aside some money through investing wisely, or have other forms of compulsory savings to provide you with a comfortable lifestyle when you retire.
Seven easy steps to work out how much money you need
STEP 1
| Determining the number of years you have until retirement |
The first thing you need to do is to determine how many years you have to achieve your retirement plan. In order words, how many more years until your retirement – this can be when you plan to retire (for instance, at age 45), or must retire (for example, age 55 or 56 in the civil service), less your current age.
Let’s take an example of Nazri, who is now 31 years old and plans to retire at age 55. The number of years to his retirement would be:
| Planned age to retire | : | 55 years |
| Less present age | : | 31 years |
| Equals number of years to retirement | : | 24 years |
STEP 2
| Determining your desired retirement income |
The next step is to ascertain how much money you will need when you retire, and are no longer working. This is difficult to predict but it is not impossible. You can estimate this by considering changes you plan to make to your spending patterns and how (and where) you plan to live after you retire. Some of your expenses will probably be lower, for example, work-related expenses (like fuel or bus fare), clothing expenses and housing expenses. On the other hand, some other expenses may increase: for example, your travel expenses, since you may have more free time. At the same time, your medical expenses may also increase, as you get older and become more susceptible to illnesses. It is often suggested that you will need about 60% to 70% of your last drawn annual income after you retire.
In our example, let’s assume that Nazri’s last drawn income is RM200,000 per year. As such, his desired annual income upon retirement would be RM120,000 (that is, 60% of RM200,000), calculated as:
0.6 X RM200, 000 = RM120,000
Once we have done this, we need to estimate how long he would need this retirement income. The number of years this income is required is a function of how long he is expected to live. In Malaysia, according to the latest information from the Statistics Department, the average life expectancy is 70 years for males, and 75 for females.
Let’s assume that Nazri expects to live till 80 years old, and as such, he would need 25 years of retirement income (from age 55 onwards).
STEP 3
| Calculating your inflation-adjusted retirement income |
Inflation is one of the most important factors to consider in retirement planning. It erodes the purchasing power of your retirement savings, and thus needs to be taken into account in your planning. Here you need to determine how much your retirement income would be, adjusted for inflation.
In our example, we know that the current value of Nazri’ retirement income is RM120, 000 (from Stap 2) and he has 24 years before he retires (from Step 1). The average inflation rate in Malaysia (from 1990 to 2001) is 3.3% - see chart below. Let us assume that the average inflation rate over the next 24 years will be 5% per annum.
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| Source: Department of Statistics |
A retirement income of RM120, 000 today at an average inflation rate of 5% would require James to have an inflation-adjusted income of RM387, 011 per annum in 24 years time. This can be calculated as:
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STEP 4
| Calculating the total funds needed at retirement |
After you have ascertained the inflation-adjusted income needed for retirement in the future, you next determine the total funds needed.
In our example, given that Nazri’s inflation-adjusted income at retirement equals RM387,011 per annum (determined in Step3), the total funds he would need can be calculated as:
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Hence, the total fund needed when he retires, 24 years from today would be approximately RM6,738,831.
STEP 5
The following step is to estimate the funds that will be available when you retire. Again, this amount is difficult to determine accurately and would depend on various factors such as the type of assets you have today, and those that you will accumulate in the future. Some of the sources of funds would include your EPF savings, personal ‘compulsory’ savings, insurance cash values, and financial assets such as stocks and unit trusts, which can be disposed of. To simplify our analysis, let’s assume that in Nazri’s case, his available funds amount to RM3,000,000 (accumulated from various sources) when he retires.
STEP 6
| Calculating the shortage (or surplus) of funds at retirement |
Once we have determined the total funds you require, and also the funds available at retirement, you can then plan for any possible shortfall.
| Total funds we require (from Step 4): | RM6,738,831 |
| Total funds available (from Step5): | RM3,000,000 |
| Total shortfall: | (RM3,738,831) |
STEP 7
| Calculating the savings required to cover shortfall |
Next, to meet the shortfall at retirement that was identified in the previous step, you need to calculate how much you must save during your working life.
For Nazri, we know that:
| His total shortfall: | (RM3,738,831) |
| No. of years to retirement : | 24 years |
| Average rate of return: | 8% |
Therefore, the amount that he would need to save in order to meet the shortfall (which is equivalent to an annuity), can be calculated as:
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We have demonstrated above how you can easily determine how much money you really need to retire, taking into account important factors such as inflation and the rate of return on your investments. The step-by-step process is intuitive, and allows you to estimate how much you need to save in order to build up your retirement fund. This will allow you to plan accordingly to achieve your retirement goals.
Summary of Retirement Planning Process
| Step 1: Determine when you plan to retire |
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| Step 2: Determine your desired retirement income |
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| Step 3: Calculate inflation-adjusted retirement income |
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| Step 4: Calculate funds needed at retirement |
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| Step 5: Project funds available at retirement |
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| Step 6: Calculate surplus/(shortage) of fund at retirement |
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| Step 7: Calculate savings required to cover shortfall |
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