Retirement is a state of mind as well as a financial issue. You are not so much retiring from work as you are moving into another stage of your "life. Some people call retirement "a "new career."
What do you want to do in that stage? Travel? Relax? Move to a retirement community or to be near grandchildren? Pursue a favorite hobby? Go fishing or join a country club? Work part-time or do volunteer work? Go back to school? What is the outlook for your health? Do you expect your family to take care of you if you are unable to care for yourself? Do you want to enter this stage of your life earlier than normal retirement age or later?
The answers to these questions are crucial when determining how much money you will need for the retirement you desire - and how much you'll need to save between now and then. Let's say you plan to retire early, with no plans to work even part-time. You'll need to build a larger nest egg than if you retire later because you'll have to depend on it far longer.
Estimate How Much You Need To Save For Retirement
Now that you have a clearer picture of your retirement goal, it's time to estimate how large your retirement nest egg will need to be and how much you need to save each month to buy that goal. This step is critical! The vast majority of people never take this step, yet it is very difficult to save adequately for retirement if you don't at least have a rough idea of how much you need to save every month.
There are numerous worksheets and software programs that can help you calculate approximately how much you'll need to save. Professional financial planners and other financial advisors can help as well. At the end of this booklet, we provide some sources you can turn to for worksheets.
Regardless of what source you use, here are some of the basic questions and assumptions the calculation needs to answer.
How much retirement income will I need?
"An easy rule of thumb is that you'll need to replace 70 to 90 percent of your pre-retirement income. If you're making $50,000 a year (before taxes), you might need $35,000 to $45,000 a year in retirement income to enjoy the same standard of living you had before retirement. Think of this as your annual "cost" of retirement. The lower your income, generally the higher the portion of it you will need to replace.
However, no rule of thumb fits everyone. Expenses typically decline for retirees: taxes are smaller (though not always) and work-related costs usually disappear. But overall expenses may not decline much if you still have a home and college debts to pay off. Large medical bills may keep your retirement costs high. Much will depend on the kind of retirement you want to enjoy. Someone who plans to live a quiet, modest retirement in a low-cost part of the country will need a lot less money than someone who plans to be active, take expensive vacations, and live in an expensive region.
For younger people in the early stages of their working life, estimating income needs that may be 30 to 40 years in the future is obviously difficult. At least start with a rough estimate and begin saving something - "10 percent of your gross income would be a good start. Then every 2 or 3 years review your retirement plan and adjust your estimate of retirement income needs as your annual earnings grow and your vision of retirement begins to come into focus.
How long will I live in retirement?
Based on current estimates, a male retiring at age 55 today can expect to live approximately 23 years in retirement. A female retiring today at age 55 can expect to live approximately 27 years. And the likelihood of living at least 20 years for someone retiring at 55 today is high - over 60 percent for a man and about 75 percent for a woman.
These are average figures and how long you can expect to live will depend on factors such as your general health and family history. But using today's average or past history may not give you a complete picture. People are living longer today than they did in the past, and virtually all expert opinion expects the trend toward living longer to continue.
What other sources of income will I have?
As of October 1999, Social Security will mail a statement to workers age 25 and older showing all the wages reported and an estimate of retirement, survivors and disability benefits. You can also request a statement by visiting the Social Security Administration's Website at www.ssa.gov or by calling 800-772-1213 and requesting a free Personal Earnings and Benefit Estimate Statement.
Will you have other sources of income?
For instance, will you receive a pension that provides a specific amount of retirement income each month? Is the pension adjusted for inflation?
What savings do I already have for retirement?
You'll need to build a nest egg sufficient to make up the gap between the total amount of income you will need each year and the amount provided annually by Social Security and any pension income. This nest egg will come from your retirement plan accounts at work, IRAs, annuities, and personal savings.
What adjustments must be made for inflation?
The cost of retirement will likely go up every year due to inflation - that is, $35,000 won't buy as much in year 5 of your retirement as it will the first year because the cost of living usually rises. Although Social Security benefits are adjusted for inflation, any other estimates of how much income you need each year - and how much you'll need to save to provide that income - must be adjusted for inflation. The annual inflation rate is 2.3 percent currently, but it varies over time. In 1980, for instance, the annual inflation rate was 13.5 percent; in 1998, it reached a low of 1.6 percent. When planning for your retirement it is always safer to assume a higher, rather than a lower, rate and have your money buy more than you previously thought. Retirement calculators should allow you to make your own estimate for inflation.
What will my investments return?
Any calculation must take into account what annual rate of return you expect to earn on the savings you've already accumulated and on the savings you intend to make in the future. You also need to determine the rate of return on your savings after you retire. These rates of return will depend in part on whether the money is inside or outside a tax-deferred account.
It's important to choose realistic annual returns when making your estimates. Most financial planners recommend that you stick with the historical rates of return based on the types of investments you choose or even slightly lower.
How many years do I have left until I retire?
The more years you have, the less you'll have to save each month to reach your goal.
How much should I save each month?
Once you determine the number of years until you retire and the size of the nest egg you need to "buy" in order to provide the income not provided by other sources, you can calculate the amount to save each month.
It's a good idea to revisit this worksheet at least every 2 or 3 years. Your vision of retirement, your earnings, and your financial circumstances may change. You'll also want to check periodically to be sure you are achieving your objectives along the way.
"Spend For Retirement"
Now comes the tough part. You have a rough idea of how much you need to save each month to reach your retirement goal. But how do you find that money? Where does it come from?
There's one simple trick for saving for any goal: spend less than you earn. That's not easy if you have trouble making ends meet or if you find it difficult to resist spending whatever money you have in hand. Even people who make high incomes often have difficulty saving. But we've got some ideas that may help you.
Let's start with a "spending plan" - a guide for how we want to spend our money. Some people call this a budget, but since we're thinking of retirement as something to buy, a spending plan seems more appropriate.
A spending plan is simple to set up. Consider the following steps as a guide, but you may want to use a computer program.
Income. Add up your monthly income: wages, average tips or bonuses, alimony payments, investment income, unemployment benefits, and so on. Don't include anything you can't count on, such as lottery winnings or a bonus that's not definite.
Expenses. Add up monthly expenses: mortgage or rent, car payments, average food bills, medical expenses, entertainment, and so on. Determine an average for expenses that vary each month, such as clothing, or that don't occur every month, such as car insurance or self-employment taxes. Review your checkbook, credit card records, and receipts to estimate expenses. You probably will need to track how you spend cash for a month or two. Most of us are surprised to find out where and how much cash "disappears" each month.
Include savings as an expense. Better yet, put it at the top of your expense list. Here's where you add in the total of the amounts you need to save each month to accomplish the goals you wrote down earlier on the "3"x 5" cards.
Subtract income from expenses. What if you have more expenses (including savings) than you have income? Not an uncommon problem. You have three choices: cut expenses, increase income, or both.
Cut expenses. There are hundreds of ways to reduce expenses, from clipping grocery coupons and bargain hunting to comparison shopping for insurance and buying new cars less often. The section that follows on debt and credit card problems will help. You also can find lots of expense-cutting ideas in books, magazine articles, and financial newsletters.
Increase income. Take a second job, improve your job skills or education to get a raise or a better paying job, make money from a hobby, or jointly decide that another family member will work.
Tips. Even after you've tried to cut expenses and increase income, you may still have trouble saving enough for retirement and your other goals. Here are some tips.
How to Prepare for Retirement When There's Little Time Left
What if retirement is just around the corner and you haven't saved enough? Here are some tips. Some are painful, but they'll help you toward your goal.
Part 3 coming next week: Avoiding Financial Setbacks
(Copyright 2001 U.S. Department of Labor. All Rights Reserved)
|INFORMATIONAL DISCLAIMER The information contained on or provided through this site is intended for general consumer understanding and education only and is not intended to be and is not a substitute for professional financial or accounting advice. Always seek the advice of your accountant or other qualified personal finance advisor for answers to any related questions you may have. Use of this site and any information contained on or provided through this site is at your own risk and any information contained on or provided through this site is provided on an "as is" basis without any representations or warranties.|