Retirement formula helps remove guesswork

You can't tell exactly what the weather will be like this winter, but you can use the temperature and precipitation record to give yourself a guide. Your situation isn't really a lot different when it comes to looking into the future to see how much money you'll need for retirement.

No, you can't tell exactly how much it will take to maintain your lifestyle. You don't know what future prices will be or how long you'll live after you retire. But you can look at some numbers that may give you an estimate. And an estimate can give you a goal to aim for. Having a goal is the first step toward achieving it. Just follow three simple steps to make your estimate.

Preliminary income need

First, how much is 80 percent of your current annual income? According to most retirement planners, you should be able to live on 80 percent of your pre-retirement income because you will be able to eliminate work-related expenses such as business wardrobe and commuting costs. For example, if you earn $40,000 a year now, your 80 percent after-retirement need is $32,000 ($40,000 x .8 = $32,000.)

After-inflation income need

Second, there will be inflation between now and retirement. How much income will you need after inflation? Just choose an inflation factor from the accompanying chart that corresponds to the number of years until retirement. (The chart uses a 3 percent annual inflation assumption.)

Next, multiply the factor by your preliminary income need. For example, if you will have 30 or more working years, your annual retirement income need will be $77,760 ($32,000 x 2.43 = $77,760)

Savings needed

Third, find approximately how much you should save in order to be able to withdraw the after-inflation income you'll need for a retirement that lasts 15 years. Multiply your annual retirement income need by 10 ($77,760 x 10 = $777,600.)

For simplicity, the multiplication by 10 includes three assumptions: a 3 percent annual rate of inflation, an 8 percent return on retirement investments, and a 15-year retirement. The actual rate of inflation, the investment returns and the length of retirement may all be different.

What about Social Security?

Making the above estimate won't give an exact answer to your retirement needs. It is a simplified calculation with assumptions for key numbers that can't be predicted with certainty. Also, the estimate doesn't include any Social Security income or the income from the future value of current assets.

Some planners doubt that future Social Security benefits will be available in their existing form. But if you will be retiring soon and are eligible for Social Security, you can anticipate monthly payments.

Do you already have some tax-deferred or taxable assets (including your home) that you will be able to use for some retirement income? You can estimate how much the assets will be worth when you retire and subtract the amount from your estimate of the retirement savings you'll need to build.

Calculating the possible future value of investments is more complicated than the simple three-step estimate above. Just as it's easier to predict this winter's weather by asking a professional weather forecaster, you can get a better estimate of your future retirement finances by talking to a financial professional.