Tuesday, October 2, 2007

Retirement Day 2:

The paper cited yesterday estimates the amount needed in retirement accounts by the time someone reaches 40 years old in order to maintain the person’s current level of consumption assuming that person lives to 95. Additionally the paper has somewhat conservative estimates on returns and savings.

Inflation rate 3 percent
nominal return 6 percent: assets (split evenly between money market and stocks),
Saving rate 7.5% total: 5 percent in a 401(k): 2.5 percent in non-tax-preferred
Includes social security benefits
house value is 2.5 times household income,
mortgage balance is 2.0 times household income

Let’s look at the three people again (the first two are from the paper, the final one is my own calculations)

1 Single, income $68,000, owns house: With these assumptions the single person will only need $14,000 by the time they are 40. With the 5% rate of savings, their assets will reach $272,000 is the next 25 years.
2. Married, income $136,000, owns house, two children: This couple will need 167,000 by the time they are 40. The model also figures in educational costs for children's college ($20,000 a year). By the time the couple reaches 65 they will need $850,000
3. A single person with income making 30,000, owns a house. By my calculations will need about $5,000-$10,00 in their retirement account by age 40 to reach a 50-50 shot of having about $250,000 when they retire including the assets of their house.

To perform the third calculation I used CNN’s financial calculator. A balanced portfolio of 50% stocks and bonds was used for savings. The third person also saved 8% of their income compared to 7.5% in the paper.

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