What’s Your Ratio?
Published on: August 10, 2015
Just kidding. I’m not retiring. I can’t afford it. But thanks for the cake with my name on it.
Have you ever reflected on your years in high school math? Take a moment and think back. Most likely you learned to solve equations for X or Y.
Geometry taught you to find the area of different shapes: triangles, rectangles, circles, trapezoids.
Maybe you even got to Calculus.
While each class deepened your knowledge of math, the numbers and methods became increasingly complicated. No doubt your teachers encouraged you with the phrase “You’ll use this again someday.”
But have you? You’re well into your career and are now able to assess the validity of that statement. Which formula has helped guide your future?
Depending on your career, the answer is likely not the formula that helped you find the length of a hypotenuse.
Take a good look at this formula. Do you recognize it?
This formula can impact your life, and you never learned it in high school. This is the Replacement Ratio formula. At the most basic level, it helps you determine what percentage of your current income you will need to replace in retirement.
Spelled out it means:
Replacement Ratio = (Gross Pre-Retirement Income – Pre-Retirement Taxes – Pre-Retirement Savings +/- Change in Expenses + Post Retirement Taxes) /Gross Pre-Retirement Income
Some of the variables in the equation depend on you and your unique situation. Only you know the answers to questions like “How will my expenses change in my mid 60s?” Your healthcare will likely go up and your dependent (children) expenses will likely go down or completely disappear. Also, you can anticipate your post-retirement taxes to decrease since you won’t be earning an income. A longer list of considerations as well as a helpful quiz can be found here.
So, why do you need to figure out your Replacement Ratio? Ideally your Replacement Ratio will help you determine your retirement plan savings rate. When you use an online financial calculator (like the one found here) to figure out how much money you will need to have on the day you retire, one piece of the puzzle will be your Replacement Ratio. It will help you know how you can sustain the lifestyle you desire throughout retirement.
So, how much money should you be laying aside now to reach your financial goals of the future?
It’s pop quiz time. Sharpen your number two pencil and get out some scratch paper. At the top of the page write your name and this question, “Will I be retirement ready?”
Remember to show your work. You may start….now!
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Written by Brandon Nicklas
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