It’s a question that everybody who isn’t a multi-millionaire finds themselves asking. How much money do I need to have saved to retire comfortably?
In fact, we get emails like this fairly often:
Hi, MoneyGeek,
My wife and I are both 56 years old.
We make about $97,000 a year and would like to retire on a similar income and keep a similar lifestyle.
We’ve saved $178,000 — about $100,000 of this is in our 401k accounts. Neither of us have pensions.
We’d like to retire at 65, but we can’t, can we?
Letters like these, and this is a hypothetical one, are never easy to answer — because, yes, this letter writer could retire at age 65 or age 57. However, it doesn’t mean it would be smart. And, of course, the math for saving for retirement is complicated, as is this crazy ride we call life that unfortunately doesn’t come with an instruction booklet. Luckily, in the case of retirement, MoneyGeek has provided tools and information to help you decide if retiring early is the best financial decision for you.
Let’s analyze this letter writer’s situation and figure out how much they need to save to retire, and most importantly, what they need to be thinking about.
Related: Freaked out about retirement? Read this
Nearly half of Americans have less than $10,000 saved for retirement. With so many companies providing support to their employees through 401(k) plans and matching, we should be doing better. However, saving and investment is not something we are taught. As we like to say, common financial sense is pretty uncommon.
In our book, Common Financial Sense, we explain exactly how to make the most of your 401(k) to fund the retirement you deserve. Here are the top 10 tips you need to invest responsibly and save enough for your retirement.
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Asset allocation is a fancy way of saying, “Don’t put all of your eggs in one basket.” It’s the way to diversify your portfolio so that you can balance out your goals, risk tolerance, and investment time horizon.
You choose your optimal asset allocation by determining how much you want to put into stocks, bonds, and money markets. The more risk you want, the more you’ll invest in stocks. The more safety you want, the more assets you’ll put in bonds and money markets.
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If you are a young investor, you may be working and earning money for 30 or 40 more years. Your time horizon is long. You may want to build a portfolio for long-term growth that has the majority of the investments in stocks.
If you are in your 50s or older, then your time horizon is shorter, so you may want to put more of your money in less risky investments like bonds, money markets, and stable value funds.
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Rebalancing refers to the process of bringing your asset allocation to your desired levels given your changing goals.
Once you have decided on your asset allocation, you should then rebalance your account at least once a year. You may assume that you can just “set it and forget it”, but you’ll have the most long term success if you make the effort to rebalance. Retirement plan investing is not for spectators — that’s why those who invest in them are called participants.
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Hopefully, you work for a company that offers a matching contribution to further assist in your retirement planning. The employer matching contribution works like this: up to a certain percentage limit, your company matches whatever amount you’ve put into your 401(k) yourself.
In the language of Common Financial Sense, employer matching on a 401(k) is free money that you should take advantage of.
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There are different ways to measure the progress of your 401(k) over time. Our preferred way to measure your progress is to compare your account balance against your long-term retirement goals. A good way to do this is to use the retirement planning calculator tool that your 401(k) plan provider has set up for you on their website.
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A popular myth about 401(k) plans is the belief that your contributions will not amount to much by the time you retire.
The most important thing to remember is that no matter when you begin or at what amount, compounding your contributions will bring you much closer to your goal than you think. The cost of waiting to put money into your 401(k) plan is extremely high. Even worse, there are no do-overs!
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People often think, “Borrowing money from my account while I’m working won’t really matter in the long run because, after all, I’m paying myself the interest.”
However, if you take a loan on your 401(k), you’ll have to pay taxes twice on the same dollars: once when you pay back the loan, since you’ll be paying with “after-tax” money, and again when you withdraw the money during retirement.
Remember that this is a retirement account, not your personal piggy bank.
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You will be given the opportunity to cash out of your plan once you leave. This is a critical mistake.
There are many disadvantages to choosing this option. You will have to pay taxes on the full amount that you receive and will most likely have some of the taxes withheld before you even receive your check. If you are under age 59 and a half, you will also have to pay a 10 percent penalty for taking the money before retirement.
Instead, roll it over to your new employer’s plan and continue investing as you were before.
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It’s important to have your legal documents in order so your assets can go to the right people when you pass away.
These include a will (which instructs how your assets will be distributed to among your surviving heirs), power of attorney (which allows someone else to step in on your behalf concerning your financial affairs) and finally, a healthcare proxy (which authorizes someone to act on your behalf for decisions related to medical issues).
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If you’re really confused, the good news is that most 401(k) plans have actively managed portfolios to choose from. The main advantage of managed portfolios is that the fund manager chooses the mix of all the funds you invest in (the asset allocation).
By allowing the professionals to determine the mix of investments and monitor their progress, you are freed up to channel your energies into other activities that you may find more productive.
This article was adapted from Harris Nydick and Greg Makowski’s book “Common Financial Sense: Simple Strategies for Successful 401(k) & 403(b) Retirement Plan Investing” and syndicated by MediaFeed.org.
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Postponing Retirement Can Help You Get More Money
Age matters a lot when it comes to retirement. We ran the letter writer’s scenario by Chuck Czajka, a certified social security claiming strategist and founder of Macro Money Concepts, a financial services firm in Stuart, Florida. He pointed out right away that the idea of retiring at age 65 is somewhat antiquated.
“If you’re going to retire at age 65, remember, it is not your full Social Security retirement age,” Czajka says. “If you begin taking Social Security at age 65, you will receive a reduced benefit check. So, you and your spouse may want to consider waiting until age 67, the full Social Security retirement age, in order to collect the full benefit.”
But according to Czajka, the letter writer might want to delay social security benefits even longer to get the most cash.
“It might make sense to wait until age 70 to get additional deferred retirement credits,” Czajka says. “Assuming you take it at age 67, you would have to fund $97,000 for the first two years and then reduce what you’re taking from retirement accounts.”
Calculate the Amount You Should Save Based on a Percentage of Your Income
Boy, does it matter. Some people become fixated on a random amount, say $150 or $300 per month, to put away for retirement. In reality, it’s best to calculate a specific amount based on the annual percentage of your income to get the most out of your retirement savings.
Czajka says that assuming the letter writer put away 15% of his and his wife’s gross income ($14,500 at 5%) for ten years, they should have an account balance of $472,322. But, as he noted, if they retired at age 65 and took Social Security at age 67, for two years, they would spend $97,000 annually. So at age 67, they would have about $278,000 left in income, plus Social Security.
“Assuming you would receive a combined Social Security benefit of $50,000 at full retirement age, you have an income deficit of about $47,000. So, in simple terms, you will run out of money in about seven years.”
Invest Sooner so You Can Retire Earlier
Obvious advice, to be sure. But the letter writer’s plight shows why. Czajka says that for the couple who wants to retire, the math for retirement might work if they had an amount of at least $700,000 in their bank accounts by the time they were 67, assuming they waited until that age to retire.
But that would be a tall order for this hypothetical couple.
EXPERT TIP
“To save $700,000 by age 67, at a 5% growth rate, you would need to save about $32,000 per year or roughly 33% of your gross earnings,” Czajka says, obviously referring to the couple’s situation and not everybody’s, adding, “Now, this is just a very broad-brush analysis. There are other factors such as getting a higher rate of return, tax rates and inflation.”
By crunching the numbers now, you can save years spent working in the future. Try using a compound interest calculator to determine how much money you’ll need to put away at what frequency and what interest rate. If you realize you’re going to come up short with your retirement money, how should you proceed?
You shouldn’t despair, according to Daniel Milan, managing partner of Cornerstone Financial Services, a wealth management firm in Southfield, Michigan.
“In my opinion, the question isn’t about how much from a percentage standpoint should someone be saving. Instead, the question should be what the goal is that you’re trying to accomplish,” he says.
So if you haven’t been putting away 15% of your income toward retirement, Milan’s advice might offer hope.
“In other words,” continues Milan, “what is the total amount of savings you are trying to accumulate in order to meet your income goals in retirement? In essence, take a goals-based planning approach rather than a percentage of savings approach. You want to determine what you need to save and invest in order to reach a specific objective. First, determine your goal and then build a financial model to determine what is necessary from an annual savings perspective.
That becomes the targeted ‘savings rate.’” But if you’re young, and you have plenty of time before you retire, aiming to put away 15% of your income towards retirement would be a good start. If you’re middle aged or approaching retirement, and you’re floundering, you may want to consider working with a financial advisor to nail down your retirement strategy.
Establish Good Financial Habits Today
We can get hung up wondering if we’re saving enough for retirement, forgetting that our future finances aren’t just based on putting money in 401(k)’s or IRAs or investing in annuities. Though, yes, that’s all important.
EXPERT TIP
In addition to saving for retirement, we should all be asking ourselves — can I be doing more to reduce my debt? If you’re spending a lot of money paying off interest, thanks to money you’re carrying on a credit card, that’s cash that could be going to your retirement.
While you should spend money on things that bring you joy, are you comparison shopping for big purchases, like a car or TV? Are you paying attention to prices when you’re engaged in less fun but still expensive activities, such as comparison shopping for car insurance?
Are you cutting coupons or downloading digital coupons before you grocery shop? These may seem like minor ways to save money, but savings add up. And if you can establish good financial habits now, those will likely carry over to retirement when money is tighter.
Still, to answer the letter writer’s question, yeah, they really shouldn’t retire at age 65.
This article originally appeared on Moneygeek.com and was syndicated by MediaFeed.org.
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How to save for retirement at 30
One of the most important things you can do for yourself in your 30s is to start prioritizing retirement savings if you haven’t done so already.
Building retirement savings at 30 is not always an easy task, even if you’re earning a higher salary as a more experienced worker. Responsibilities often increase along with your salary, but it’s important to keep retirement in mind even as you hit other milestones such as buying a house or starting a family.
To save for retirement in your 30s, you’ll need to balance your day-to-day spending with your long-term goals. The sooner you can begin saving for retirement the better.
You can set yourself on a path to healthy retirement savings with the following strategies, starting with putting money into a designated retirement plan.
Here’s how to get started.
Related: 6 steps to max out a 401(k)
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Saving in tax-advantaged retirement accounts available through work, known as a 401(k), is one of the best things you can do to start saving for retirement. Your 401(k) allows you to contribute up to $20,500 per year in 2022, up from $19,500 in 2021.
Contributions come directly from your paycheck with pre-tax dollars, which lowers your taxable income in the year you make them.
Coupled with the benefits of compounding interest, this feature can help your savings grow even faster. Starting a 401(k) at 30 still gives you several decades for your funds to grow over time.
Also, 401(k)s allow employers to contribute to your retirement, and many will offer matching funds as part of your compensation package. Aim to save at least as much as is required to receive your employer’s match. Work toward maxing out your contributions, especially as your salary grows over time.
You can access the funds penalty-free once you reach age 59-and-a-half, but you will owe taxes on the money at that time.
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An IRA is a retirement account, which anyone with earned income can open. If you don’t have a 401(k) at work, opening an IRA can give you access to a tax-advantaged savings account. If you already have a 401(k), opening an IRA can be a good way to save even more, though you won’t get to write off your contributions.
For 2022, contribution limits to IRAs are $6,000 per year, the same as in 2021.
IRAs come in two different flavors: traditional and Roth IRAs. If you don’t have a 401(k), you can make contributions to traditional IRAs with pre-tax dollars. Like a 401(k), money in these accounts grows tax-deferred, and you’ll pay the taxes on it when you make withdrawals in retirement.
If you meet certain income restrictions, you may be able to contribute to a Roth IRA instead. In that case, you’ll make the contributions with after-tax dollars, but your money will grow tax-free inside the account, and you do not have to pay taxes when you make withdrawals.
Recommended: Traditional vs. Roth IRA: How to choose the right plan
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Diversification is the act of spreading your money across different asset classes, and to minimize risk from a decline from one type of asset, it typically makes sense to create a diversified portfolio, including a mix of asset classes, including stocks, bonds and other assets.
Your asset allocation refers to the proportion of each asset class that you hold. Your asset allocations will reflect your goals, risk tolerance and time horizon. Given the relatively long period until your retirement, you might consider a relatively aggressive portfolio consisting mostly of stocks in your retirement account.
Stocks typically provide the most potential for growth, but they also fluctuate more than some other asset classes. Since you have three decades or more before you retire, you have time to ride out the natural ups and downs of the market.
Bonds, which tend to be less volatile than stocks but also offer lower returns, may balance out the riskier equity allocation. As you approach retirement, you may consider rebalancing your asset allocation to include more conservative investments to help protect the income you will need to draw upon soon.
Target-date funds are a type of mutual fund that automatically readjusts your portfolio as you near your target date, often the year in which you wish to retire.
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Just as a portfolio with different types of assets offers some downside protection, so too, does diversification within those asset classes as well. If you the entire stock portion of your portfolio shares in just one company. If share prices in that company drop, the value of your entire portfolio drops as well.
Now imagine that you own shares in 500 different companies. When one stock fares poorly, it will have a relatively small effect on the rest of your portfolio. Diversification helps limit the negative effects that any asset class, sector, or company could have on your portfolio.
You can further diversify your portfolio by including companies from different sectors and of all sizes from different parts of the globe. This same idea holds true for other asset classes. For example, you could hold a mix of government and corporate bonds, and the corporate bonds could represent companies from various sectors and locations.
One way to add diversification to your portfolio is by investing in mutual funds, exchange-traded funds (ETFs), and index funds that themselves invest in a diversified basket of stocks. For example, if you buy shares in an ETF that tracks the S&P 500 index, you’ll be investing in the 500 stocks included in that index.
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If you’re only in your 30s, it’s likely that you’ll change jobs a couple of times, or more, over the course of your career. When you change jobs, you’ll have a number of options for what to do with the 401(k) you hold with your previous employer.
One of these options is to cash out your 401(k). But this is typically not a great idea from a personal finance perspective. If you take a lump sum payment and you’re younger than 59-and-a-half, you may not only owe income taxes on the withdrawal, but also a 10% early withdrawal penalty. What’s more, your money will no longer be working for you in a tax-advantaged account, potentially setting you back in your retirement savings goals.
A better option is to roll over your 401(k) into another tax-advantaged retirement account, such as your new employer’s plan, if they offer one, without paying income taxes. Or you can roll your 401(K) into an IRA without paying taxes. IRA accounts offer the added benefit of additional investment options, and they may have lower fees than your 401(k).
Recommended: How to transfer your 401(k) when changing to a new job
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An injury or an illness that keeps you from going to work can hamper your retirement savings plan. However, disability insurance can help cover a portion of your lost income — usually between 50% and 70% — for a period of time.
Most employers offer some sort of short-term disability insurance, with a benefit period of three to six months. Some employers may offer long-term policies that cover periods of five, 10, or 20 years, or even through retirement age.
Check with your employer to see if you are covered by a disability policy and whether it provides enough coverage for your needs. If your employer’s plan falls short, or you don’t have access to one, you might consider purchasing a policy on your own.
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The earlier you can start saving for retirement the better. A long-time horizon gives you the opportunity to take advantage of compounding growth for a longer period of time, which can help you increase the amount you’re able to save. Pay attention to the fees you’re paying on investments, which can eat away at returns over time.
Learn More:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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