Many factors should be considered when determining an accurate savings goal: the age at which you would like to retire, your life expectancy, current investments, contribution rates and the impact of inflation.

When determining the amount you must save, make sure to factor inflation into your retirement plan. Inflation can affect the future purchasing power of your retirement savings. Remember that even after you have stopped working, inflation marches on!

GOOD NEWS! Most pension plans automatically factor in a cost of living increase. Of course, you will need to check with your employer to see what that amount will be. Social Security also has a cost of living adjustment. Keep in mind that these automatic increases, combined with your other income sources, may not be enough to protect your purchasing power after retirement.

BAD NEWS! Inflation keeps working long after you stop working. If you retire at age 60 with a yearly income of $50,000, the purchasing power of this amount could drop by 45% in 20 years. Therefore, in 20 years you would need a yearly income of $90,300 to maintain the same lifestyle. 

As you can see, inflation can have a very dramatic effect during a long retirement, so it is important that you plan for these effects.

Retirement Scenario: Bruce’s Retirement Projection

What is your savings goal? A simple way to start is by reviewing a retirement scenario, Bruce’s Retirement Projection.

Bruce is 44 years old and plans to retire when he is 62. He has 18 years to make sure he plans for the life he imagines for retirement. He begins his retirement projection by taking his current income of $61,000 and increasing it by 3% per year until his retirement. He chose 3% because he expects his wages to increase with the average historical rate of inflation.

After setting his lifestyle goals and reviewing his basic living expenses, Bruce determines he will need about 80% of his current income for retirement or $48,800 per year for his living expenses.

Then, based on the information provided by his employer and his annual statements from pension and Social Security, Bruce totals the income of the sources at $34,140.

Finally, Bruce estimates the cost of his retirement living expenses and subtracts it from the income he expects to receive from his pension and Social Security. He finds that he will have a shortfall. Bruce will need to supplement his yearly income by $14,660 to reach his retirement goal.

How Much Should Bruce Save?

Accounting for inflation and a life expectancy of age 85, Bruce will need to have a nest egg of $392,000 by the age of 62 to maintain his lifestyle during retirement. You can get the number by using the Retirement Planning Report.

Next, Bruce needs to determine if his current course of action will put him on track to reach his retirement asset goal. Currently, Bruce has $32,000 in his tax-qualified plan. Also, he is saving $400 per month and has been averaging a return of 7% per year.

However, based on his current course, Bruce will be short of his retirement asset goal. The good news is that Bruce has several ways to get on track for his retirement goal. 

Take a look at his options and the one he chooses.

What Can Bruce Do?

Increase savings. Bruce could have found additional savings on a monthly basis to save for retirement. Unfortunately for Bruce, he was already at the end of his budget by saving $400 per month. 

Retire later. Bruce could have chosen to retire later than age 62. Bruce is not open to this option. Can you blame him?

Lowered expectations. Bruce could give up some of his lifestyle expectations for retirement. Instead of going to Hawaii every year, he could go every 10 years instead. Bruce did not choose this option.

Increase his investment returns. Bruce has been averaging a return of 7% on his money. He could choose to change his investment strategy and try to increase his return. In fact, this is exactly what Bruce chose to do. He diversified his investments. And by using asset allocation to help reduce the risk on his investments, Bruce's goal is to average a return of 9.5% per year. Keep in mind, neither asset allocation nor diversification ensure a profit or protect against market loss.

Bruce decides that he will be able to achieve his retirement goal by changing his risk tolerance and his investment strategies. For Bruce, the investment decision was the right choice. But any of those options may have been appropriate for you. The point is that by taking the time to create a plan, Bruce puts himself in control of his retirement. He now knows that he may be closer to meeting his retirement goals.