I know I’ve talked about this topic a thousand times, and honestly I’ll never get tired of talking about it. A lot of times, people have this misconception that you can start saving for retirement at an advanced aged, and live the rest of your life-like a king. Ok fine, it is possible, but the price you’ll have to pay to get there, I doubt if most people would survive their second year. The other thing is that there is no ‘one fits all’ ultimate guide to retirement because of the unique circumstances every person is going though, and the following article from the editors of Money Magazine gives the basic steps necessary for retirement.
When should I start saving for retirement
The answer is simple: as soon as you can. Ideally, you’d start saving in your 20s, when you first leave school and begin earning paychecks. That’s because the sooner you begin saving, the more time your money has to grow. Each year’s gains can generate their own gains the next year – a powerful wealth-building phenomenon known as compounding.
Here’s an example of what a big difference starting young can make. Say you start at age 25, and put aside $3,000 a year in a tax-deferred retirement account for 10 years – and then you stop saving – completely. By the time you reach 65, your $30,000 investment will have grown to more than $472,000, (assuming an 8% annual return), even though you didn’t contribute a dime beyond age 35.
Now let’s say you put off saving until you turn 35, and then save $3,000 a year for 30 years. By the time you reach 65, you will have set aside $90,000 of your own money, but it will grow to only about $367,000, assuming the same 8% annual return. That’s a huge difference.
Where should I save my retirement money?
Tax-favored retirement accounts such as individual retirement accounts (IRAs) and 401(k)s are the best places to save for your retirement. The different types of plans have different features, but most of them allow you to defer taxes on the money you save and the returns you earn within the account.
“Tax deferral” means that the amount you contribute escapes the usual income taxes until you start withdrawing the money years later. As a result, more of your money can earn investment returns over time – an enormous advantage over ordinary taxable accounts.
The plans have other advantages as well. For example, many employers will match part of their workers’ contributions to employer-sponsored retirement plans such as 401(k)s.
How should I invest the money?
To build a nest egg large enough to see you through retirement, which may last 30 years or more, you’ll need the growth that stocks provide.
The stock market returned 9.8% a year on average between 1926 and 2009, versus just 5.4% for bonds, according to research firm Ibbotson Associates. Given stocks’ superior returns over the long haul, most financial advisers recommend that investors whose retirement is more than 20 years away hold at least 3/4 of their portfolios in stocks and stock funds.
Of course, a stock-heavy portfolio can give you some hair-raising moments (or years). For example, during the 1973-74 bear market, U.S. stocks lost 43% of their value – and it took the market three-and-a-half years to recoup those losses. The stock market also suffered a 47.6% decline during the bear market at the start of this decade.
If you don’t have the stomach for steep downturns, you might increase your allocation to include more bonds or bond funds. Holding, say, 70% of your portfolio in stocks and 30% in bonds will let you capture most of the long-term growth of stocks while sheltering your investments to a certain extent during market downturns.
How should my strategy change as I get older?
As you approach retirement age, most experts agree you should gradually shift more into bonds to protect the money you’ve accumulated. But retirement can last a few decades, so it generally pays to maintain a healthy dose of stocks well into retirement: possibly between 40% and 50% while you’re in your 70s, and up to 30% when you’re in your 80s.
If you want to put your asset allocation on autopilot, consider “target-date retirement funds,” which are available in many retirement plans. You simply choose a fund that’s labeled with the year you intend to retire, and it will automatically adjust what it invests in (usually a mix of stocks, bonds and cash) to maximize your return and minimize your risk as you get older.
How much money will I need in retirement?
Ah, the key question. One rule of thumb is that you’ll need 70% of your pre-retirement yearly salary to live comfortably. That might be enough if you’ve paid off your mortgage and are in excellent health when you kiss the office good-bye. But if you plan to build your dream house, trot around the globe, or get that Ph.D. in philosophy you’ve always wanted, you may need 100% of your annual income – or more.
It’s important to make realistic estimates about what kind of expenses you will have in retirement. Be honest about how you want to live in retirement and how much it will cost. These estimates are important when it comes time to figure out how much you need to save in order to comfortably afford your retirement.
One way to begin estimating your retirement costs is to take a close look at your current expenses in various categories, and then estimate how they will change. For example, your mortgage might be paid off by then – and you won’t have commuting costs. Then again, your health care costs are likely to rise.
Will pensions and Social Security be enough?
Unfortunately, probably not. When you run the numbers, you should definitely factor in other sources of income in retirement, including Social Security and a traditional pension, if you’re lucky enough to have one. But your personal savings will have to generate enough income to cover the shortfall.
You can check your estimated Social Security benefits by using the government’s Social Security Online calculators. Current or former employers can provide estimates of any pension benefits you might receive when you retire.
How much should I save?
“As much as you can” is the standard advice. Many financial planners recommend that you save 10% to 15% of your income for retirement, starting in your 20s.
But that’s just a general guideline. This is your retirement we’re talking about, so it pays to get a little more specific by doing your homework up front. It’s a good idea to establish a savings target – one that tells you roughly how much you should set aside over time to meet your retirement goals.
The best way to determine your savings target is to use an online calculator like this one. It will help you figure out how much you should accumulate and how much you must set aside in the meantime to reach that target. Be sure to update the calculation each year, so that you can see if you’re on track.
As a general rule, you’ll need at least $15 to $20 in savings to cover each dollar of the annual shortfall between your income and your expenses. So for example if your projected retirement expenses exceed Social Security and pensions by $20,000 a year, you might need a nest egg of $300,000 to $400,000 to bridge the gap.
What if I can’t save enough?
Try to divert as much of your earnings into savings as you can. If you don’t have a budget, create one. If you do have a budget, revise it to reflect your newly urgent commitment to saving, as well as any changes in your spending since your last outbreak of budget fever. Chip away at wasteful habits – that might mean ditching expensive dinners or unused gym memberships.
If you’re still young and you can’t save enough right now, don’t be discouraged. Your income will probably grow as you progress in your career, allowing you to save more. You might also have other opportunities to boost your savings rate; for example, a bonus or inheritance can make a big difference in your long-term prospects if you invest some of the money in retirement accounts.
How can I reduce the amount I’ll need?
The most obvious way is to rethink your standard of living in retirement. Swapping the around-the-world sailing trip for a Caribbean cruise may help you lower your retirement target to a more attainable goal.
You can also delay your planned retirement date from, say, 62 to 68 or so. Working past the traditional retirement age will let you postpone withdrawals from your retirement accounts. Your savings will have more time to grow, and you’ll reduce the number of years you’ll need to draw on them. Working longer may also let you delay taking Social Security until you reach at least full retirement age (66 if you’re 50 today), potentially increasing the size of your monthly benefit by 30% or more.
The great thing about online retirement savings calculators is that you can play with the numbers to see exactly how much more or less you’ll need to save based on when you plan to stop working, or how much you’ll spend in retirement, or any number of other factors.
Working part-time can help too. But the problem is that you don’t know if you’ll have the interest or energy to work at an advanced age – or if you’ll have health problems that prevent it. You also may have a tough time finding an employer who wants to hire you in your later years for the amount of money you want to earn. So pinning your entire retirement strategy to working in your 70s or beyond isn’t such a great idea.
What if I’m running out of time?
If you find yourself running short on time – say, you’re in your 40s or even your 50s, and you haven’t gotten started yet – there are still a few things you can do. The key is to do them now.
You should first max out your contributions to tax-favored retirement accounts like IRAs and 401(k)s. For 2012, the IRS allows $17,000 for a 401(k) (though your employer may impose lower limits), and $5,000 for traditional and Roth IRAs. If you’re over 50, you can contribute additional catch-up contributions. Even the government understands that this is crunch time, and it has devised a few ways to help you out.
For example, workers age 50 and older can put more money into IRAs and workplace retirement plans than younger savers can. That means you can and should contribute an additional $5,500 to a 401(k) and $1,000 to traditional and Roth IRAs.
If you’re arriving late to retirement planning, a traditional IRA may be a better choice than a Roth.
I’m saving a lot but will still fall short – what now?
Consider other alternatives that can reduce how much you need to save. The most obvious one: Think about delaying retirement by a few years. That strategy will allow you make more contributions to your retirement accounts while postponing withdrawals – which could significantly increase the size of your nest egg even as it reduces the amount you need to accumulate to make it through retirement.
For example, if you retire today at age 65 with $500,000 in retirement savings and withdraw $43,000 a year, your savings likely would last until you reached age 90. But if you delay retirement for another five years and max out your IRA contributions during that period, you would retire at 70 with $772,680 saved. That nest egg would let you withdraw $72,000 a year until age 90. (Calculations assume an 8% annual return on your investments.) So by delaying your retirement just five years, you can increase your retirement income by nearly $30,000 a year.
Getting a part-time job after you retire also can make a big financial difference – and can provide mental, physical and emotional benefits as well. Other options include trading down to a less-expensive home (you can invest the profits toward retirement), reining in your spending or transforming the equity in your home into income by taking out a reverse mortgage – though high costs mean this last option is a good idea for only a small number of retirees.
When can I retire?
Trying to figure out whether you can afford to retire is like putting together pieces of a financial jigsaw puzzle. First, you need to estimate how much you’ll spend in retirement. Then you must consider the income you’ll collect in retirement from pensions and Social Security – as well as the amount you can afford to draw from your personal savings or other sources.
The idea is to assemble the various pieces, and then see whether the picture of retirement life that emerges is acceptable to you.
To help bring the retirement picture into better focus, try plugging all your pertinent financial information – including pensions, Social Security, retirement investment accounts and anticipated retirement expenses – into an online calculator. The calculator can crunch all the numbers and assess your odds of being able to retire on the schedule you envision.
Revisit the calculator and all the different pieces of the puzzle each year, in order to make sure you remain on track.