It wasn’t so long ago, your dad keeps telling you, that he began saving for your college tuition when you stood no taller than his knees. Back then, graduation parties seemed a long way off and his own retirement even further. But here he is today, looking squarely into the face of his golden years. How time flies!
He talks about how difficult it was to put money aside so early. And now with your own child in your arms, you understand how difficult it was for him not to look at retirement as a destination many years, if not decades, down the road. Moreover, given the current economic climate, it’s difficult for you to think about the distant future, when there are so many immediate financial concerns facing you today.
But the sooner you begin planning, the more financially secure you’ll be when you retire. In fact, with an early and prudent plan, you could retire even a few years sooner than you might expect.
When thinking of retirement planning, ask yourself these three questions:
What will it cost to live once you retire?
Many financial advisors project that your living expenses after retirement will be about 70% to 80% of your income before you retire. For a couple retiring today with a combined income of $80,000, it means a retirement income requirement of between $56,000 and $64,000.
But it’s not as simple as that. Let's assume you are currently earning $45,000 per year, that you are 30 years old, and that you want to retire at 60. Let’s also assume that your income will increase 5% a year until you retire. That means that your annual income before you retire will be more than $170,000. If you require 70% of that amount after retirement, you will need almost $120,000 a year. That sounds like a huge number, but that is what a 5% annual raise can mean over time. In addition, inflation will also make everything more expensive.
Estimated annual living expenses after retirement.
|Current household income|
|Years to retirement||$30,000||$40,000||$50,000||$60,000|
Assumptions: Expenses after retirement will be 70% of pre-retirement expenses, 5% wage increases, taxes are ignored. Numbers are rounded.
How much do you need to save?
To answer this question, you will have to make assumptions about Social Security, decide whether you want to deplete your savings during retirement or leave assets to heirs, and predict how long you are going to live. All of these are difficult assumptions.
Let's assume that (1) Social Security benefits (about $1,876 per month for an average couple) will increase 3% annually, (2) you will earn 3% on your savings, (3) your expenses after retirement will increase by 3% annually, and (4) you live for 30 years after you retire. Even if you are willing to deplete all of your savings over those 30 years, you will still need to save about $1.5 million!
What can you do now to start saving?
If you are like most, the numbers are overwhelming if not shocking. But don’t let their sheer size make you think that a financially secure retirement is beyond reach. If you begin early, time really is on your side. You will have many years to put money aside, with compounding tax-deferred earnings and income tax laws working in your favor.
In planning for retirement, there are four sources of income available to you.
Social Security Benefits – While there has been a lot of political debate over the future of Social Security, it is highly unlikely that it will be eliminated. You contribute to the program through automatic deductions from your paycheck and, in return, expect to receive benefits when you retire. However, you will probably not be able to live on Social Security benefits alone. Currently, the average monthly benefit for a retired couple is about $1,876.
While there is not much you can do to affect the size of Social Security benefits, there are things you can do to supplement income from the other three sources of retirement income.
Employee Retirement Plans – Most companies, especially larger ones, have recognized that providing qualified plans for employees’ retirement helps them retain employees. 401(k) plans have become very popular because both the company and the employee can contribute funds to the plan. In addition, the government has increased the amounts that companies and employees can contribute to the plans. For 2009, employees can contribute up to $16,500, which is not subject to income tax. Your employer can also contribute up to $49,000 (total employee and employer contributions). If it is offered and if you are able, contribute enough to get the full employer match.
Individual Retirement Accounts – IRAs are another primary tool to accumulate funds for retirement. There are two kinds of IRAs: “regular” and Roth. For 2009, individuals can contribute up to $5,000 annually into either type of IRA. Over time those contributions can add up dramatically. In addition, earnings on IRAs are not taxed so your money grows even faster. For example, if you contribute $5,000 a year for 30 years and your funds earn 6% (compounded over time), your retirement nest egg could add up to almost $405,000.
If you are contributing the maximum to your company retirement plan and still have some extra funds, consider an IRA.
Other Savings – While savings and investment accounts do not enjoy the tax preferences of 401(k) plans and IRAs, they are still important components of most individuals’ retirement income. Consider taking advantage of savings plans that automatically make monthly transfers to a savings account or investment account. Be sure that your investment strategy takes into consideration your financial goals, time horizons and risk tolerance.
The cumulative amount of funds you will need for retirement may appear daunting. But if you start early and stick to a purposeful and prudent financial plan, your goals can be achieved over time. Moreover, taking action now can provide peace of mind that your retirement will be secure and allow you to enjoy life fully and comfortably.