Most people must provide for their own retirement by setting aside during their working years. Figuring out how much you’ll need and how much to save requires significant guesswork and assumptions. Retirement planners often develop their own calculations using several common assumptions, and can quickly determine how much you will need at retirement and plot out ways to get there in the remaining time.
Planning Your Nest Egg
Retirement plans often focus on a single dollar amount that you needs to have on hand for retirement. A lump sum figure provides a simple target. Calculating a simple nest egg saving’s goal requires converting the income stream you’ll need in retirement and adding any cash cushion you want for special purposes. These calculations vary with assumptions about inflation rates and methods for funding a retirement income stream.
Retirement Uses for Annuities
Annuities exchange a lump-sum payment for smaller periodic payments. The concept is used to calculate the upfront value of an income stream given a specified interest rate and repayment term. Insurance companies offer annuity contracts that allow people to make that exchange, often giving annuity owners a flexible payment term that lasts as long as the owner is alive. Retirement planners use annuity calculations to convert an income stream to a saving’s goal, and you might use your nest egg to purchase an annuity to make sure you don’t outlive your money.
Annuity and Retirement Tax Calculations
Planning a monthly budget on a fixed income requires precision, and the variability of the tax code introduces plenty of complexity to budgeting. Annuities and retirement savings plans generally follow the same tax rules. Income from the plan is taxed as ordinary income, even if it comes from selling capital assets. After-tax money put into the plan can be recovered tax free, but might be recovered proportionally over the course of a periodic payment plan. The exclusion ratio, which is the amount of after-tax money divided by the anticipated payout, sets the portion of each periodic payment is tax-free.
Heuristic Retirement Calculations
Among the many considerations that retirement planning involves are how much income you’ll need during retirement, how long you’ll need the income, what rate of return you’ll get on your savings, how much a dollar today will be worth when you retire and how you’ll use your nest egg to fund your retirement. With so many variables, even a detailed calculation can wildly miss the mark. Many investment firms offer simple heuristic calculations that factor in several assumptions and leave one variable for people to plug in. One firm advises that you save eight times your final year’s salary by retirement.
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