How to Use Your Personal Balance Sheet to Plan for Retirement

Now that you have your personal balance sheet, here’s how to use it and begin visualizing your retirement.

To apply the personal balance sheet to your own retirement plan, your first step is to think about how much you spend now and how much you will need in retirement. I discussed this process in my first post in this series, “How to Create a Personal Balance Sheet.”

From my experience, people tend to need more than what they are spending now during their first seven years of retirement. This is because people generally like to celebrate their retirement with travel and other flights of fancy that they didn’t have the time to pursue before.

After the first seven years, things tend to settle down as people kick back and enjoy their time at a more leisurely pace. Therefore, their spending tends to relax as well.

Planning for Inflation

Let’s say you need $80,000 a year right now, and you plan on retiring in 10 years. If we assume a constant inflation rate of 4%, then in 10 years you will need $119,000.

Annual Household Income x Inflation^n = Necessary Income in Year n

80,000 x 1.04^10 = 119,000

To account for the fun stuff people like to do when they celebrate their retirement, we’ll add $6,000 to make their target income in year 10 come to $125,000.

Calculating how much Investment Income You Need

From the $125,000, you can deduct social security and any pension benefits (referred to as “retirement accounts,” in Part 1). Lets say neither you nor your spouse has a pension, but you have $45,000 from Social Security.

Gross Income – Social Security and Pensions = Investment Income

$125,000 – $45,000 – 0 = $80,000

In this case, your minimum portfolio income will need to be $80,000 annually throughout your retirement.

So How Much Do I Need to Retire?

To aim for your own unique retirement goals, you need to know a couple things. First, your Net Worth, which was covered in Part 1. Second, you should know at what age you would like to retire. For that, I refer you to the Social Security Administration’s 2010 Period Life Table.

While your withdrawal rate may vary depending on those two variables, a 4% withdrawal rate is generally considered to be a low enough number that it will last throughout retirement, assuming that inflation is contained to about 2% and returns on the portfolio are greater than inflation.

The 4% you are withdrawing every year needs to equal your present-value $80,000 that you calculated using your personal balance sheet.

A quick way to do this is to multiply 80,000 x 25, which equals $2,000,000.

$2,000,000 = Retirement goal

(Keep in mind that this is a rough estimate.)

As we refer back to the personal balance sheet, we see how much we have now, and we know that you need to get to roughly $2,000,000 in retirement if we will want to live on $125,000 the year you start retirement in 10 years.

Proper planning begins at understanding where you are. Your personal balance sheet gives you a step-by-step process to determine how much you have now. From there, you can begin to think of your goals and determine what is a realistic retirement goal. Hopefully, using the rule-of-thumb guidance I provide here will help you get a clearer picture of the path ahead. However, there are always nuances and caveats involved in responsible financial planning, so I encourage you to consult a financial professional as you make a plan to enjoy your retirement years as best you can.

James Cornehlsen, CFA, is a Portfolio Manager at Capstone Investment Financial Group.