Friday, December 21, 2012

What I can do with my Lifetime Income Number

I recently wrote an article about calculating my lifetime income needs. Obtaining this number involved looking at my estimated life expectancy, my past expenses, and my lifestyle inflation rate in order to determine what my expenditures would be over the next 45 years. Doing this allowed me to develop an average cost per year, which in turn gave me an overall amount that I would need to hit to continue in my current lifestyle from now until death.

While it’s not a perfect formula, it begins to help me take some of the financial guesswork out of life moving forward. Sure, there are plenty of unknowns; but that’s life. As much as I love to ponder and plan, I’m realistic. I know I can’t plan for everything. But I can plan for a lot.

Here are some of the things that having that lifetime income number helps me do using numbers and examples that don't pertain to my actual financial situation.

My Calculation
First off, here’s a quick review of my previous article and the equation I used to calculate my lifetime income number, using $20,000 (this isn’t my expense number, but it works for this example) as my current annual expense number and 3 percent as my annual lifestyle inflation number over the next 45 years (my life expectancy):

“Personally, I make this calculation by way of a financial calculator that I keep handy on my desk, but it can also easily be done by way of a future value online calculator, by inputting:

Present value: $20,000

% Change per time period: 3

Time periods: 45

Future value: $75,631.92

All things remaining constant, this tells me that my annual expenses could be running in the area of $75,631.92 by age 80 (kind of scary, isn’t it?). If I add that number to the current expenses of $20,000, I find that my expenses will average out to be about $47,815.96 per year or $2,151,718.20 over the course of the next 45 years.”

Looking at Income Needs
Having an idea of how much money I’ll need on an average annual basis can clarify a litany of work-related and career questions. If I know that I should be averaging $45,000 a year to build a secure current lifestyle not only for my family but a secure future and retirement lifestyle for myself as well, but I’m only making $30,000 a year right now, something needs to change. I either need to reconsider my current work situation, find more income streams, dramatically cut expenses or do some combination thereof.

Pulling Out Social Security
So let’s stay with my $45,000 a year annual average as my income needs number over the next 45 years. And let’s say that by using the benefits estimator at the Social Security Administration website, I can determine that by the time I retire, my benefits might be somewhere in the range of $1,500 a month – or $18,000 a year. This means that my retirement funds must provide me with and additional $27,000 to make up the difference. If my savings can’t do this, then maybe I need to reconsider my investment options or I need to pick up some work during retirement or even bump up my retirement age.

Determining Retirement Age
After seeing my income needs and Social Security benefits, I can begin to put a finer point to my retirement age number. Knowing that if I wait until age 70 to retire, that my monthly payments might be $2,000 instead of $1,500, I could wait to take my benefits in order to bolster my retirement income. Or working an extra five years or so could provide me with enough money to increase my income from retirement savings. If nothing else, it might tell me if I need to mix some amount of income earning work into my retirement to supplement Social Security and retirement savings income streams.

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