In planning for retirement, you have probably crunched many numbers: the value of your investment portfolio, the income stream from Social Security or a pension, your projected annual spending, and your life expectancy. What if you could distill all those figures into a single number that tells you whether you're on track for a secure retirement?
Some advisers and academics say the "funded ratio" allows you to do just that. To calculate this figure, you divide your total assets -- including the current value of your investment portfolio and the present value of future income such as Social Security -- by the present value of your total projected retirement spending. (Present value is the value of a future sum or income stream in today's dollars.)
If you arrive at a figure of more than 100%, your retirement plan is likely on sound footing. If it's less than 100%, you may need to think about working longer or reining in expenses.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The funded ratio "incorporates a lot of data and boils the answer down to a single stat," says Phill Rogerson, a managing director at Russell Investments, which is promoting the use of the funded ratio among financial advisers. By tracking the figure closely, he says, retirees can "maximize the lifestyle they can live today while minimizing the probability they run out of money before they die."
A rising or falling funded ratio can send a signal that your retirement plan is growing more secure or hurtling off a cliff. To be sure, precisely calculating the present value of future income streams and total lifetime retirement spending isn't simple. You need to "discount" those future dollar amounts to reflect the time value of money -- the principle that $1 in your pocket today is worth more than $1 in the future, since money can earn interest over time. The calculation also must take into account your life expectancy.
Fully Funding a Retirement
Here's an example from Russell Investments: A 68-year-old couple have a $1 million investment portfolio and projected retirement income (including Social Security and pensions) worth roughly $722,000 in today's dollars. They figure their annual retirement spending will be $62,500, rising 2.6% annually with inflation. Factoring in longevity assumptions and taxes, their total spending amounts to $1.45 million in today's dollars. So their funded ratio is 119% ($1.72 million in total assets, divided by $1.45 million in spending).
A financial adviser can help you calculate and monitor this figure on an ongoing basis. And for do-it-yourself types, advisory firms are launching free online tools that help individuals calculate their funded ratio. For example, Koch Capital Management, an Alamo, Cal.-based advisory firm that started using the funded ratio with clients last year, is offering such a tool online at www.kochcapital.com (click on "Resources"). Russell Investments plans to offer an online funded-ratio calculator by the end of the year.
The funded ratio is a concept borrowed from the defined-benefit pension world. Pension plans track their financial health by dividing their assets by the present value of benefits they must pay to participants. When they're underfunded, they may need to make additional contributions to cover the shortfall.
So what can individuals do when they're "underfunded" -- or headed that direction? For preretirees whose funded ratio is below 80%, "retirement is not an option at this point," and they should keep working until their funded ratio recovers, says Jim Koch, founder and principal of Koch Capital Management.
Retirees should be on high alert if their funded ratio drops below 105% or 104%, Rogerson says. They should cut back nonessential expenses to keep their funded ratio from dropping below 100%.
And what if your retirement is overfunded? With a funded ratio of 125% or more, Rogerson says, retirees are "so well funded, they can think about doing other things with their money," such as giving gifts to charity or leaving it to heirs.
-
What Does Medicare Not Cover? Eight Things You Should KnowHealthy Living on a Budget Medicare Part A and Part B leave gaps in your healthcare coverage. But Medicare Advantage has problems, too.
-
15 Reasons You'll Regret an RV in RetirementMaking Your Money Last Here's why you might regret an RV in retirement. RV-savvy retirees talk about the downsides of spending retirement in a motorhome, travel trailer, fifth wheel, or other recreational vehicle.
-
457 Plan Contribution Limits for 2025Retirement plans There are higher 457 plan contribution limits for state and local government workers in 2025. That's good news for state and local government employees.
-
13 Smart Estate Planning Movesretirement Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money.
-
Medicare Basics: 12 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
The Seven Worst Assets to Leave Your Kids or Grandkidsinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2025SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $70,000 in 2025, up from $69,000 in 2024.
-
Roth IRA Contribution Limits for 2025Roth IRAs Roth IRA contribution limits have gone up. Here's what you need to know.
