1. Take your salary
2. * 0.8
3. * 1.03 ^ number of years til you retire
4. - any social security you expect to get
5. * 20.
The answer is how much you need to save. The method is pretty simple but it should give you a ball park idea.
A brief discussion:
The 0.8 is pretty arbitrary - but is trying to get at what amount of your current salary you could live off - hopefully the kids will have left home and your house is paid off. So this number could be 0.7 or less -but don't kid yourself here.
This is to try to get a handle on inflation. Most forecasts (from long term bonds etc) peg inflation as being pretty low in the future. So 3% should take account of any increases in your cost of living.
Social Security. You can got the Social Security website and they'll tell you what your benefit is going to be. http://www.socialsecurity.gov/estimator/
This has nothing to do with you living for 20 years. By multiplying by 20 you are creating a lump sum that could yield 5% income per year that would be enough for you to live on. So this step assumes that you invest your retirement portfolio in an account that earns at least 5%.
If you already have some money saved then you can add the following steps:
6. Take dollar amount you have saved *1.05 ^ number of years.
This will give you an estimate of how much your current money will grow to.
2. Subtract this from the answer from #5 above. This is the new amount you need to save.
3. To find out the amount you need per month, enter this formula in to excel =PMT(0.05/12,12*years,0,amount needed).
This should give you the amount that you need to be saving each month for the rest of your working life assuming 5% return on your investments. Arguably this is a little conservative as your income and amount saved will be going up.
Salary = 100,000, and 20 years to retire.
$200,000 saved currently.
$1,500 SS benefit per month = 18,000 per year.
Assume investment portfolio earns 5% a year.
80% = 80,000
- 18,000 = 62,000
62,000*1.03^20 = $130,000
130,000*20 = $1.44 Million.
Looking at current save money:
200,000*1.05^20 = 530,000
Amount to save = 1.44 M - 530,000 = 910,000
Using excel formula:
=PMT(0.05/12,240,0,910000) = 2,213 per month for the next 20 years (or about 22 % of your gross income).