A Guide to Measuring Nest Eggs

A new look at Americans’ use of 401(k) savings plans suggests that people may be preparing for retirement far better than many experts had worried they would.

The study of 2003 data on plans covering 35% of the estimated 42 million 401(k) participants showed that, on average, Americans have been setting aside adequate sums, investing wisely and consistently.

“You come away pretty optimistic,” said Jack VanDerhei, a business professor at Temple University and a fellow at the Employee Benefit Research Institute, which helped conduct the study and reported the results last week.

But when the subject is retirement finances, averages don’t tell individual savers much, if anything, about their personal situations.

If you’re fortunate enough to have a 401(k) plan, or are able to save diligently for retirement in other tax-deferred accounts, how can you know whether you’re putting enough away?

Here’s a relatively easy exercise that can help you get your bearings and at least provide a ballpark estimate of your future retirement nest egg, and whether it would meet your needs:

* Step one: Figure the future value of your current savings.

The average 401(k) balance was $76,809 at the end of last year, according to the study released last week. But account totals vary widely by age and the number of years a person has contributed to a plan.

For example, people in their 20s had an average of $23,888 saved. That figure rose to $29,689 for people in the same age group who had been with the same company for more than five years, the study said.

People in their 50s had an average of $112,854 saved in 401(k) assets. That figure rose to $146,509 for people in their 50s who had been with their company for more than 30 years.

Whatever your current balance, what might it be worth when you finally retire? The first of the accompanying charts can help you guesstimate the future value of current savings.

In the chart, determine approximately how many years you have until retirement. Then pick an estimated annualized average return for your savings over that period. Find the corresponding number in the chart, then multiply it by your current nest egg.

How do you estimate a reasonable return? That’s always tricky, but some historic data may help.

According to data firm Ibbotson Associates, a portfolio made up of 50% stocks; 40% bonds and 10% cash (money market accounts) has generated an average annualized return of 8.25% since 1926.

Many experts, however, suggest that investors lower their expectations for the stock market, in particular, over the next decade or so. So a conservative estimate of long-term returns on a diversified portfolio might be in the range of 6% to 7%.

Consider a hypothetical 40-year-old who has his age group’s average savings of $82,999 in a 401(k) account today. He figures he’ll earn 7% on his money over the next 25 years, so he multiplies the $82,999 by 5.43, from the chart. His savings would be worth $450,685 when he’s 65.

* Step two: Figure what additional savings might be worth at retirement.

The key to building a significant nest egg is to save consistently, as difficult as that can be for many people.

To determine what your current savings regimen might generate over time, use the second of the accompanying charts.

Multiply the amount you save each month by the appropriate figure in the chart.

If our hypothetical 40-year-old was able to save $500 a month in a 401(k) plan -- and stick with that savings program until retirement -- he’d multiply that by 810.07, which is the chart figure that corresponds with a 7% return over 25 years.

The potential value of his future savings at retirement: $405,035.

* Step three: Figure what income level you might need in retirement.

Based on the calculations above, our hypothetical 40-year-old would have a nest egg worth $855,720 at retirement (adding $450,685 and $405,035).

Would that be enough to support him? He could, of course, have other savings to tap as well -- for example, home equity. And Social Security, hopefully, would provide some income.

Calculating what income level would be comfortable in retirement is always difficult, given the number of variables involved. Many day-to-day expenses should decline in retirement, while others (for medical care, for example) could rise.

Many financial advisors suggest this goal: Your nest egg and supplemental income sources should be able to generate between 70% and 100% of whatever your final annual income is just before retirement.

Let’s assume our 40-year-old would want to have at retirement an annual income in today’s dollars of $40,000 before taxes.

That sum would have to be adjusted for inflation over the next 25 years. It’s impossible to know what the inflation rate will be over the next 25 years, so our saver will have to guess. Let’s assume he figures that inflation will run at a 3% average annual rate in that period, which is about the historical average since 1926.

The third chart above provides inflation-adjustment multipliers based on a 3% inflation rate.

Our 40-year-old would multiply $40,000 by 2.094, which corresponds with retirement in 25 years. That tells him he would need annual income of $83,760 in 2029 to have the current buying power of $40,000.

* Step four: Figure what your nest egg might generate in income during retirement.

Most people take a more conservative approach with their savings as they get older, reducing the potential return in favor of greater principal protection.

Let’s assume our saver would expect to earn 5% a year on his nest egg after age 65.

Based on a portfolio worth $855,720, a 5% return would generate annual income of $42,786.

That would mean our saver would need income of about $40,000 from other sources to meet his annual goal of $83,760 in retirement.

If additional income wasn’t forthcoming, he could either reduce his spending, tap into the principal value of his nest egg, or some combination of the two.

Savers who do these calculations and realize that they may fall short of the income they’ll need in retirement have three options: start saving more, plan to retire later, or plan to live on less in the future.

All of these calculations provide only back-of-the-envelope estimates of what savers might need, and what they might face. But it’s a starting point if you’re wondering how you’re doing compared with that mythical average American.

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Retirement Savings Calculators

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Step 1

Calculate future value of current savings

Use these multipliers to determine the future value of your current nest egg, based on time to retirement and assumed rates of return.

*--* Time to Assumed annual rate of return: retirement 6% 7% 8% 9% 5 years 1.34% 1.40% 1.46% 1.53% 10 years 1.79% 1.97% 2.16% 2.37% 15 years 2.40% 2.76% 3.17% 3.64% 20 years 3.21% 3.87% 4.66% 5.60% 25 years 4.29% 5.43% 6.85% 8.62% 30 years 5.74% 7.61% 10.06% 13.27% 35 years 7.69% 10.68% 14.78% 20.41% 40 years 10.28% 14.97% 21.72% 31.41%

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Step 2

Calculate future value of additional savings

Use these multipliers to determine the future value of additional monthly savings over time, based on time to retirement and assumed rates of return.

*--* Time to Assumed annual rate of return: retirement 6% 7% 8% 9% 5 years 69.77% 71.59% 73.48% 75.42% 10 years 163.88% 173.08% 182.95% 193.51% 15 years 290.82% 316.96% 346.04% 378.41% 20 years 462.04% 520.93% 589.02% 667.89% 25 years 692.99% 810.07% 951.02% 1,121.12% 30 years 1,004.51% 1,219.97% 1,490.36% 1,830.74% 35 years 1,424.71% 1,801.05% 2,293.88% 2,941.78% 40 years 1,991.49% 2,624.81% 3,491.01% 4,681.32%

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Step 3

Calculate future income needs

Use these multipliers to estimate future annual income needed to match a current figure, assuming 3% average annual inflation.

*--* Time to Income multiplier retirement with 3% inflation 5 years 1.159 10 years 1.344 15 years 1.558 20 years 1.806 25 years 2.094 30 years 2.427 35 years 2.814 40 years 3.262

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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past columns, visit latimes.com/kristof.