Beginning to Think About Retirement Planning

Retirement is probably many years, if not decades, in the future. Yet, being able to afford a financially secure retirement is expensive and understanding some of the basics now and taking a few steps can make that retirement you dream of a reality and maybe even let it start a few years sooner than what you think.

Any discussion on retirement planning ultimately comes down to a few basic issues:

• What will it cost to live after I retire?
• How much do I need to have saved before retirement?
• What should I be doing now?

What will it cost to live once I retire?

The answer to that question is truly unknown and the numbers can be staggering. Many financial advisors suggest that your living expense after retirement will be about 70% to 80% of what they were before you retired. For a couple retiring today with a household income of $80,000, that means they will probably spend $55,000 to $65,000 after they retire.

Estimating your retirement income needs gets a little more complex. Let’s assume you are currently earning $50,000 per year, that you are 35 years old and that you want to retire at age 65. You expect your income to go up 5% a year from now until you retire. That equates to an annual income before you retire of over $216,000. If you spend 70% of that amount after you retire, that means you will be spending almost $151,000 per year. That sounds like a huge number, but that is what 5% raises can mean and remember that inflation will make everything more expensive.

Estimated annual living expenses after retirement.

Assumptions: Expenses after retirement will be 70% of pre-retirement expenses, 5% wage increases, taxes are ignored. Numbers are rounded.

How much do I need to have saved before retirement?

The answer to this question gets more complex because you have to make assumptions about Social Security, decide whether you want to deplete your savings during retirement or leave assets to heirs, and guess how long you are going to live. All of those are difficult assumptions.

Let’s go back to our example and assume that Social Security benefits (about $2,596 per month for an average couple) will increase 3% annually, you earn 3% on your savings and that your expense level after retirement increases 3% annually. If you live 30 years after you retire and you are willing to deplete your savings over the 30 years of retirement, you would have needed to accumulate about $2,700,000 by the time you retire. If you earn 5% on your savings and start now, you would need to save over $3000 each month to reach that goal.

What should I be doing now?

The numbers in our example seem very large. But do not let their sheer size make you think that a financially secure retirement is beyond your reach. In fact, a young age works very much in your benefit. You have many years to put money aside for your retirement, the benefits of tax deferred compounding work in your favor and the income tax laws provide help.

You will have four sources of income when you retire, three of which you have control over.

Social Security Benefits – While there has been a great deal of political debate over the future of Social Security, no one is seriously talking of eliminating it. You pay into the program through deductions from each paycheck and you will probably receive benefits from the program when you retire. However, Social Security benefits alone will probably not enable you to afford the retirement lifestyle you want. For 2024, the average monthly benefit for a retired couple is about $2,972.

Realistically, there is very little you can do to affect the size of Social Security benefits you will receive when you retire.

Employee Retirement Plans – Most companies, especially larger ones, have recognized that providing qualified plans to accumulate funds for employees’ retirement makes sense. 401(k) plans have become very popular because both the company and the employee can contribute funds to the plan. The government has also recognized this and has increased the amounts that companies and employees can contribute to plans. For 2024, employees can contribute up to $23,000 into a 401(k) plan. In addition, for 2024 the company can put additional funds into the plan up to a total (employee and employer) of $69,000.

There are three things you can do to increase your 401(k) plan balance:

• Participate in the plan. You usually sign up for the plan when you are hired.
• Contribute as much as you can out of your wages into your account. The amount you contribute is not subject to income tax and the more you contribute the more you will accumulate.
• Most 401(k) plans have some form of employer matching contribution formula. Each plan is different but try to contribute enough to get the full employer match.

Individual Retirement Accounts – IRAs have become a primary tool to accumulate funds for retirement. There are rules about IRA eligibility and deductibility, and there are regular IRAs and Roth IRAs. For 2024, the annual contribution limit is $7,000, and over time those contributions can add up dramatically. In addition, earnings on funds within IRAs are not taxed so your money grows faster. By contributing $7,000 each year for 30 years and earning 6% on the funds can add almost $566,400 to your retirement nest-egg.

If you are contributing as much as you can to your company retirement plan and still have some extra funds available, contribute to an IRA.

Other Savings – The final source of retirement income will be your other savings. Accumulations in savings accounts and investment accounts, while not enjoying the tax preferences of 401(k) plans and IRAs, are still a major component of most individuals’ retirement income. Saving more and earning more on these funds can add greatly to your retirement lifestyle.

Consider taking advantage of automatic savings plans with monthly transfers to a savings account or investment account. Also, be sure that your investment strategy is sound with consideration given to your goals, your time horizons and your risk tolerance.

Some conclusions

• Your cost of living after retiring is going to be high, perhaps even scary.
• To have enough money to retire with a lifestyle you want means that you must accumulate a great deal of money before you retire.
• The future of Social Security is uncertain, and you should not count on Social Security providing enough to make your retirement comfortable. It may just help some.
• Company retirement plans and IRAs provide additional tax benefits that make accumulating funds easier. Contribute as much as you can to these plans and save additional funds in personal accounts.

Time is on your side. Starting to take actions now can provide peace of mind that you are doing the right thing and will provide the funds for the retirement you want decades in the future.