The 1.2.3 to Retirement Planning

The issue of retirement planning has always been of great interest to me because like planning for a long holiday, retirement is also a very long journey that needs a lot of pre-planning. But because the destination is a far way off, and also because it is such a tedious job to prepare for it now, most leave it until too late to prepare for it.

Retirement planning essentially boils down to a few numbers, and three magic formulas which you can tap on MS Excel to compute for you. Retirement Calculator

First we need to critically decide on the following –

a. How much money will I need when I stop working?

b. How long should my monthly income last?

c. When do I intend to stop working?

d. How much returns am I getting on my savings?

e. What is the expected long term inflation rate?

f. How much can I save monthly for retirement starting from today?  

Does it seem like too much to think about already? Fortunately, we do have a national savings plan that helps us decide. Based on this savings plan, the answers to the above questions are –

a. About $1000 per month in present dollars. This works out to be about the average monthly expenditure of a person in the median income range according to the Household Expenditure Survey 2007/8 Table 22

b. No one really knows when they will pass on so ideally the income should last as long as you live. However as we will need hard numbers to do computation, I will use the current life expectancy of about 82 years, which means the monthly income should last at least 18 years

c. The official retirement age of 65 years old

d. Somewhere between 2.5% to 5% per annum without bearing too much risk, or an average of about 3.75%

e. Long term inflation rate in Singapore is about 2% per annum

f. Depends really on how much I earn yah? But since industry standards say at least 10% of my gross income, let’s go with that. The average income of a person in the median income range is about $2,20o, 10% of that is $220 or $2,640 annually.

So armed with these key data, I will now use the power of Excel to do some maths –

First to calculate how much I need to have when I reach 65 years old, use the PV function with the following inputs –

rate = [(1 + Rate of Return)/ (1 + Inflation Rate)] – 1

= (1.0375/1.02) – 1

= 1.72%

The return needs to be adjusted for inflation otherwise your retirement income will not be hedged against inflation during your retirement years.

nper = 18 (years)

pmt = $12,000 ($1,000 monthly income x 12 months)

fv = 0 (unless you want to leave a fortune for your beneficiaries)

With these inputs in, the magic number that is required at age 65 is $184,000 in today’s dollars. But the story doesn’t end here, unless of course you are 65 years old today. If you’re younger than 65 years old, you’d need to also factor what $184,000 would be worth when you turn 65 years old.

The second step then would be go back to Excel and use the FV formula with the following inputs –

rate = 2% (which is the inflation rate)

nper = years before you reach 65 years old (for me that’s about 30 years from now)

pmt = 0

pv = 184,000 (that’s the amount you need if you retire today)

Once again, voila, the magic number that comes up is $333,000. This is the amount I will need to save up to by the time I reach 65 years old.

Now the third step involved is to find out how my current savings plan is working to help me reach this retirement goal. To do that I use the PMT formula.

rate = 3.75% (the average return on the national savings plan)

nper = 30 (years I have to save for retirement)

pv = 0 (assuming I have zilch savings for my retirement at this moment)

fv = 333,000 (what I need by the time I reach 65 years old)

And so now I get to know if my current savings of $2,640 annually is enough to help me reach my retirement goal, and the answer is NO! I would actually need to save about $6,200 annually or 23% of my income to reach my retirement goal.

At this point, while it is heart breaking to recognise that it actually takes effort to save for your retirement, don’t sweat it. You’re about halfway there. To actually realise your goal, a few adjustments obviously has to be made on items a, c, d and/or f.

a. Are you willing to live on less than $1000 per month?

c. Would you want to continue working after 65 years old?

d. Is there anyway that you can earn better returns than 3.75%?

f. Can you save more than 10% of your income per month?

Conversely, if you’ve done your sums and realised that you can reach your goal easily, you can also revise your expectations on these items upwards – to have more than $1,000 per month, to stop working earlier than 65 years old and/or save less than 10% of your current income. I’ve done up a Retirement Calculator which you can download to help you figure this out. It’s quite idiot proof I hope.

Now for those of who really really really cannot be bothered to do the maths after all said and done, my advice to you is to just depend on the national savings plan to do the work for you. Leave all your contributions (36%, that’s even more than the required 23%) in the plan to grow and accumulate, don’t touch it for your home purchase (or only a little bit) and you’re set for retirement, without even having to rack your brain on all these maths or lift a finger to save more or find investments with better returns.

By the way, if you are Singaporean and reading this post, you ought to know what national savings plan I am talking about. If you don’t, drop me a note and I’ll enlighten you. =)