Many individuals are finding that they must postpone their retirement target dates or cancel retirement because they are not financially ready for it. If you find yourself in such a predicament, you may find solutions to this dilemma if you look carefully. If not, you've at least learned a valuable lesson - one that you can and should pass on to your children. Let's look at some of the sometimes-harsh lessons the current generation of retirees and pre-retirees has to teach. (See Laid Off? You Can Still Retire for tips on retiring during hard times.)
Lesson No.1: Don't Finance Your Children's Higher Education at the Expense of Funding Your Retirement Nest Egg
Parents often have the best of intentions when they choose to pay for their children's higher education, but the cost can erode retirement savings and/or negatively impact the parents' ability to add to their retirement nest egg. For instance, a parent who chooses to take PLUS loans or private loans of $120,000 ($30,000 per year over a four year period) to pay for her child's college expenses may end up repaying an average of $186,000.
As a parent, it may make you feel good to know that your children will not be saddled with repaying student loans when they starts their journey to financial independence. But, before you get too comfortable with that feeling, consider that your children have several options for financing their education, while you are solely responsible for financing your retirement through retirement savings account, regular savings and social security contributions. (For more on college loans, see College Loans: Private Vs. Federal.)
Lesson No.2: Don't Overextend Your Debts and/or Ruin Your Credit
Having unmanageable debts can negatively impact your ability to add to your retirement nest egg, as you may find yourself unable to even meet those debt obligations. Debt repayments reduce your disposable income, resulting in a reduction of the amount available for adding to your retirement nest egg. Having too much debt can also result in a poor credit rating.
A poor credit score can negatively impact your ability to get lower interest rates on loans, and higher interest rates mean higher loan repayment amounts. For instance, consider an individual obtaining a $250,000 30-year mortgage. At an interest rate of 7% you would pay total interest of $348,680 and have a monthly repayment amount of $ 1,663. If that individual was able to obtain the mortgage at 5.5 % due to good credit history, the amount of interest repaid would be $260,840 and the monthly repayment about would be $1,419. The difference of $87,840 in interest repayments could have been added to the individual's retirement nest egg.
In fact, if the $244 difference in repayment amounts were added to a savings account instead, it could result in an accumulated savings of approximately of $169,000 at a conservative interest rate of 4%. Even at 2%, it would result in a savings of $120,000, which can go a long way in covering expenses during retirement. (To learn more about the power of compounding on savings, read Delay In Savings Raises Payment Later On.)
Lesson No.3: Prioritize Saving For Retirement
Retirement savings should be added to your budget as a fixed expense and increased as your disposable income increases. However, retirement is often viewed as a distant event that can be put on the financial back burner; by the time these individuals are ready to implement their retirement savings regimen, it becomes burdensome. Consider that an individual who needs to have $1 million in his retirement nest egg at retirement will be required to save more per year for each year that savings are delayed. Let's look at some numbers to demonstrate this point.
|Years to Fund||Planned Payment (Per Year)||Total Payments||Total Earnings @ 5.5%||Accumulated Value|
If you want to save $1 million, assuming a rate of return of 5.5%, you would need to save $6,938 per year if you start saving 40 years before you aim to retire. If you wait until 10 years later, you would need to save $13,085 per year. The amount grows each year you neglect to save. The higher savings amount for the shorter savings periods may make it much more difficult to meet the savings goal.
Lesson No.4: Don't Fail to Design a Customized Investment Portfolio
A significant portion of losses on retirement savings can be attributed to improper and unsuitable asset allocation models. For instance, a portfolio with too much allocated to one type of stock (or just stocks in general) can experience a significant loss if the stock market falls. Diversifying investments can help to mitigate risks and use gains in some areas to offset losses in other areas.
There is no one-size-fits-all solution when it comes to investing your retirement savings. Instead, your asset allocation model is affected by factors such as your risk tolerance, retirement horizon and your age. Your portfolio can be designed to include different classes of assets, and different categories within each class. For instance, you may choose to allocate 20% of your portfolio to stocks, and may further break down that percentage into healthcare, energy and other types of stocks so as to further diversify your investments and balance your risks.
Don't fail to rebalance. As your portfolio experiences losses and gains in different areas, you will need to rebalance your allocations so as ensure that your portfolio continues to be suitable for your financial profile. (To learn more, read Rebalance Your Portfolio To Stay On Track.)
Lesson No.5: Look at Alternative Retirement Options
Being behind the retirement eight-ball does not mean that you cannot retire. Instead, it may mean considering alternate options, such as taking nontraditional retirement routes. For instance, you could:
- Work longer: If you planned to retire at age 65, working for an additional five years could make a big difference. You Social Security payments would increase and the income from working could be used to pay down debts and add to your retirement nest egg. (Also read How Much Social Security Will You Get? to gauge how much you're entitled to.)
- Spend less and save more: Limiting your expenditures to necessities and increasing your savings can make a big difference to the balance in your retirement accounts. For instance, if you reduce your expenses by $250 per month for five years, at a rate of return of 4% you would save about $16,000 extra.
- Phase-in retirement: Retirement does not have to be a one-shot process. Instead, it can happen gradually. For instance, instead of retiring at age 60, you could continue to work on a part-time basis and gradually reduce your hours over the years until you can afford to fully retire. (For more insight, see Stretch Your Savings By Working Into Your 70s.)
The Bottom Line: Teach your children to learn from your mistakes
One of the best ways to impart knowledge to your children is by sharing true life experiences. You can share book strategies and other theoretical mediums with your children, but the lessons they will likely remember and learn from the most are those that are centered on the mistakes you've made. If you find yourself behind in saving for your retirement, help your children to understand how you got there and help them to understand the things you could have done differently that would have resulted in more positive outcomes. (Read Journey Through The 6 Stages Of Retirement to learn about the emotional planning aspect of retirement.)