In last week’s column, we looked at three retirees who had not made adequate financial plans to ensure that they could enjoy their golden years. To achieve a financially stress-free retirement, you have to create a proper strategy to replace your working income while you’re still employed.

One of the ways to generate retirement revenue is to invest over time to build a nest egg that will eventually provide the income you’ll need. Planning for an event that’s far in the future is not a simple process, so you must seek advice from a financial advisor. Here’s a look at what the retirement planning process entails:

Step 1:   Establish the Planning Parameters

The advisor will need to know your current financial situation in order to estimate the cost of your desired retirement lifestyle. Experts usually approximate 70 percent to 80 percent of your present expenses for retirement income needs; as some costs such as children’s bills, mortgages and car loans should hopefully gone at that time.

Think carefully about your desired retirement age, as this will affect the number of years you have left to save towards your retirement fund. You’ll also have to anticipate your life expectancy to determine the number of years your nest egg should last. The advisor will ask simple questions to find out your comfort level in taking financial risks in order recommend the right investments for you.

Step 2:   Calculate how much money you will need

To estimate your required nest egg size, an advisor will use a retirement calculator that will project your money into the future. The examples below have been calculated with financial tools from www.planningtips.com . A link to these tools is available at www.financiallysmartonline.com.

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Let’s say that you would like your retirement fund to supply you with an annual income of J$600,000 (in today’s dollars) when you retire in 20 years time at age 60. You estimate that you will need this income consistently for another 25 years. What amount would your nest egg need to be, to allow you to enjoy this lifestyle?

If we use an average annual inflation figure of ten per cent, then your annual income requirement will actually be J$4,036,500 when you retire in 2028. This figure will continue to increase by 10% every year during your retirement, so that you are not negatively impacted by rising costs. The calculator also estimates that you will continue to earn a net return of eight per cent annually on your investments. In order to achieve this goal, you will need to have accumulated a nest egg valued at approximately J$126,872,430 by 2028!

Now if this figure sounds unbelievable think what J$500 could have bought 25 years ago, if you’re old enough to remember. In my case, it was more than enough to buy Christmas gifts for everyone I knew!

Step 3:   Calculate how much you will need to save

So now you’re faced with this whopping nest egg requirement figure. What kind of savings plan do you need to ensure that you can reach this total in 20 years time?

Let’s say that you can start your retirement fund with J$100,000, and you can comfortably save J$10,000 monthly with a ten percent increase every year to stay ahead of inflation. Your advisor informs you that you can expect an average return on your investments of ten percent per annum over the next 20 years. Using the assumptions in the example above, your savings plan would give you a nest egg of only J$16,744,777, while your requirement is J$126,872,430. This would mean that your retirement savings would run out within five years time.

Although this result is depressing, there are several things you can do to create a more realistic plan. You can increase your initial lump sum and monthly savings; you can reduce the amount needed in retirement; you can try to get a higher rate of return on your investments; and you can extend the time that you’ll be contributing to the plan by postponing retirement.

Step 4:   Choose appropriate investments

The advisor will then help you to choose the right investments to achieve your nest egg target, bearing in mind your risk comfort level and the time frame of your goal. These investments should be tax-free, and should take into account the effects of inflation and the depreciation of the Jamaican dollar on your future purchasing power.

Step 5:   Review and adjust your plan

After you have decided on a plan of action, it’s important to periodically review the performance of your investments. Has your portfolio been growing according to the original plans? Have there been changes in your lifestyle or the economy that could affect the overall outcome of your savings plan? Also, as you approach retirement you will need to modify your investment plan by reducing allocations in riskier investments and consolidating your accounts to provide a consistent income stream.

Next week we will look at the developments in Jamaica’s pension industry, focusing on the improvements that will help self-employed persons to save for retirement.