Saving for Retirement: The Quest for Success
The main goal of a successful retirement program is to ensure you will have sufficient financial resources to maintain or improve your lifestyle during your retirement years. If you want to travel and make more purchases in retirement, you will have to save more. How much you will need to save will depend on how you want to spend your retirement.
According to some financial planning experts, you will need to save enough so that your retirement income is in the range of 70% to 80% of your pre-retirement income. You will need a higher percentage if you plan to improve your standard of living. If you have more expenses in retirement than before retirement, your retirement income may have to be more than your pre-retirement income.
“Some financial advisors believe that a retirement income of 70-80% of pre-retirement income is sufficient. While that may be true for some people, many will find that they are not happy with that level of income. Consider that, although it is easy to increase spending, it is quite another to reduce it. Retirees who take a 20-30% cut in pay will feel it in a reduced lifestyle,” says James B. Twining, CFP®, founder and CEO, Financial Plan, Inc., Bellingham, Wash.
Building up your savings requires careful planning, which includes assessing your current assets, the number of years left until you retire and how much you'll be able to save during your pre-retirement years. In this article, we list some of the steps to take when implementing your retirement program.
Determine What You Will Need
One popular approach to retirement planning starts with determining how much you'll need to finance your retirement years.
This is usually based on projected cost-of-living increases, the number of years you're likely to spend in retirement and the lifestyle you plan to lead during retirement. But projecting an amount isn't an exact science: The years you spend in retirement may be more or less than you project, and the same may go for cost-of-living increases.
However, a comprehensive outlook and some thought will help to provide realistic projections. Here are some factors to consider:
- Your projected everyday living expenses
- Your life expectancy
- Your projected costs
- Your resources (other than your retirement savings) that can cover unplanned expenses; such resources may include long-term care insurance, annuity products and health insurance
- Your property: If you own your home (i.e. have no outstanding mortgage balance) or will own your home by the time you retire, you have the option of selling it or obtaining income through a reverse mortgage.
- Your intended lifestyle during retirement: Do you plan to lead a quiet retirement or engage in activities, like traveling around the world, that may be expensive?
Take Stock of What You Have
If you are not a financial planning expert or don't have the time necessary to implement and manage a retirement program, you may need the help of a competent financial planner.
If you do see one, he or she will need to assess your current financial status in order to design a realistic and successful retirement program. You will need to provide detailed information about your financial affairs.
“Planning for retirement is like planning for a trip. It is easier to plan for the journey if you know your starting point. While gaining insight on how clients see their retirement lifestyle is important, knowing their current financial status is [a key] part of the process. It helps determine the ongoing strategy for saving and protection,” says Russ Blahetka, CFP®, managing director, Vestnomics Wealth Management, Campbell, Calif.
Documents your financial planner may need generally include copies of your most recent account statements, including regular savings, checking, retirement savings, annuity products, credit cards and other debts, as well as:
- A copy of amortization schedules or summaries of any mortgages
- Copies of your tax returns for the last few years
- A copy of your most recent pay stub
- Health and life insurance contracts
- A list of your monthly expenses
- Any other documents you think may be important to your financial planning process
Once you have factored in the above considerations, it's necessary to determine how much you will need to save on your own. First consider the possible sources of income you will have during retirement. A complete retirement income package is commonly referred to as a "three-legged stool," comprising your Social Security, employer-sponsored retirement plans (such as a qualified retirement plans) and, finally, your personal savings. So, of course, the amount of personal savings you need to achieve depends on the contributions to retirement accounts by your employer and your projected income from Social Security.
Your next consideration is the type of saving vehicle you use for your personal savings – this will affect your required annual savings. The amount varies depending on whether your means of savings are in pre-tax, after-tax, tax-free or tax-deferred accounts or a combination thereof. The type of savings account you choose depends on – among other things – whether it is better for you to pay tax on your savings before or after retirement.
Saving in a tax-deferred vehicle, such as a traditional IRA or 401(k) plan, may reduce your current taxable income. If you have a 401(k), your taxable income is reduced by what income you defer to the plan, and if you have a Traditional IRA, you may be able to claim your contributions as a tax deduction. Earnings in such vehicles also accrue on a tax-deferred basis, but the assets are taxed when you distribute them from the retirement account. You may pay less in income taxes on amounts saved on a pre-tax basis if you make withdrawals during retirement and your income tax rate is lower than it is in your pre-retirement years.
By using post-tax funds to save for retirement, you won't have to pay tax again when you withdraw them during retirement. However, your earnings on post-tax funds are usually not tax deferred. So when you withdraw these amounts, they may be taxed at your ordinary income tax rate or at a capital gains rate, depending on the type of income and the duration for which you held the investments.
If you are eligible for a Roth IRA, you may want to ask your financial planner whether it is beneficial for you to use one even for only part of your savings. Roth IRAs are funded with after-tax assets, earnings accrue on a tax-deferred basis and distributions are tax free if you meet certain requirements.
“There are two reasons it is important to have after-tax investments as part of your retirement plan. First, if you do such a great job saving that you can retire before age 59½, you need money you can access without a 10% early withdrawal penalty. Second, it’s nice to have some diversification of your tax bill in retirement so that every account withdrawal doesn’t get taxed at regular income tax rates,” says Kristi Sullivan,CFP®, Sullivan Financial Planning, LLC, Denver, Colo.
Find Extra Money
It's one thing to figure out how much you need during retirement, how much you need to save and what account you will use to do so. But the primary challenge is finding the extra funds to put toward savings, especially if your budget is already spread thin. For many, this means changing spending habits, re-budgeting and redefining needs vs. wants.
“Separating your personal budget between discretionary and non-discretionary spending helps create a baseline in terms of what you need versus what you want. Seeing the life you want to live in detail can incentivize you to save more in order to live that life,” says Mark Hebner, founder and president, Index Fund Advisors, Inc., Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”
Once you are able to allocate a part of your monthly income to your savings, you need to think about investing those amounts. Investing puts your money to work for you and usually gives you the benefits of compound interest. Investing is integral to ensuring your retirement program meets your goals. And the earlier you start, the easier it will be for you to do so.
“I suspect that many over-think the process of saving for retirement. Let me suggest three simple guidelines that can be started today by anyone. First, start setting aside some money each month. A good goal is 10% of your monthly income. It may take years to achieve that goal, but any amount of savings is better than none,” says Craig Israelsen, Ph.D., designer of the 7Twelve Portfolio, Springville, Utah. “Second, automate your saving and investing – that way it happens without you having to remember and the minimum needed to open a mutual fund is often lower if you automate your investments. And third, don’t over-manage your investments. When some of your mutual funds are not performing well, be patient and invest more. Buying low, being consistent and exercising patience – the hallmarks of successful long-term investors.”
The types of investments that are suitable for your portfolio will depend primarily on your risk tolerance. Generally, the closer you are to your targeted retirement date, the lower your risk tolerance will be. The idea is that those who have a longer time until retirement have more opportunity to recoup any losses that may occur on investments. Someone who is in his or her early twenties may have a portfolio that includes more high-risk investments such as stocks. Someone who is in his or her sixties, on the other hand, will have a higher concentration of investments with guaranteed rates of return such as certificates of deposit or government securities.
Regardless of risk tolerance, it is important to achieve an appropriately diversified portfolio, one that maximizes return for its determined risk.
Finally, if you do not already have a competent financial planner, or you are looking for one, be sure to shop around and check the background of anyone you plan to interview.
The Bottom Line
This article discusses some of the fundamental groundwork for ensuring your retirement program is successful – but this is only an overview. The underlying details will take time and effort for you to determine and execute. And the steps outlined above do not make up a catch-all solution. Your financial planner should be able to help ensure that all important factors are considered. In the meantime, don't be afraid to conduct some research on your own, by visiting websites, such as the U.S. Social Security Administration, which provides useful information and calculators for retirement planning. Understanding the Social Security Website will help you get started.
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