- July 07, 2020
It’s not as hard as you think to start saving for retirement.
For many of my clients, when I bring up the subject of retirement planning, they start squirming in their chairs. Their discomfort is obvious — they feel guilty or ashamed about not having saved much (if anything), and they may even joke, “Oh, I’ll never be able to retire. I’ll just work until I die!”
Most people, it seems, believe they’ll need millions upon millions of dollars to properly retire. Recently I heard $5 million was the approximate amount. And some are so overwhelmed by this presumed sum that they throw up their hands and say, “Why bother? I’ll never have enough.” Retirement, for them, is as elusive and dreamlike as unicorns or the Loch Ness monster.
But you may not need as much as you think. Sure, we’d all like to have $5 million in the bank to retire with — that sure would make life comfortable. But chances are, to maintain your current lifestyle, you should follow this good rule of thumb: Figure that you’ll need 70 percent of your pre-retirement salary to live comfortably in retirement. So if you earn $100,000 a year now, you should plan to have 70% of that, or $70,000 per year saved, for each year of your retirement. There are several caveats to that rule, which I’ll go into in a minute, but here’s the basic formula for calculating your retirement savings goal:
(Current gross salary x 70%) x (the number of retirement years) = Retirement savings goal
So if your pre-retirement gross salary is $100,000, and you plan to retire at age 65, you can generally expect that retirement to last for 20-30 years. So here’s what that formula would look like for you:
$70,000 x 30 (years) = $2.1 million
That total would need to be adjusted for inflation as well as the growth of your savings. The 2019 rate of inflation was 2.3%, but it literally changes every day — especially in these turbulent times we’re living in. For simplicity, using 2% as annual inflation rate should work for this analysis. For annualized average returns on investments, one can safely use 6% based on historical market performance.
Right about now, you’re probably looking at your own total and worried that you’ll never have millions of dollars of cash in the bank. Don’t panic. The majority of us won’t have it.
But remember: This doesn’t mean you need to have $2.1 million (or whatever your final total is) in the bank as cash upon retirement. This is a cumulative total of assets. Remember that Social Security, pensions, real estate, businesses, and anything in your investment portfolio is included in that total.
I don’t know about you, but having a specific figure as a goal makes it seem more doable. Rather than socking money away blindly toward a vague, undefined goal, you can be more strategic about how much you can put away each year, or even each month or week.
Typically, you want a mix of the following retirement income:
- Taxable income: This “bucket” contains money put in AFTER taxes, but any growth is entirely taxable. These accounts are also extremely liquid and easily accessed. Your emergency fund should be in this bucket. It includes interest income earned from such sources as mutual funds or Certificates of Deposit, stock dividends, or capital gains, as well as income earned from rental properties.
- Tax-deferred income: This include withdrawals from any retirement plans to which you contributed pre-tax dollars, such as a traditional IRA, 401(k), most pensions, annuities, etc.
- Tax-free income: This bucket contains money for which you have already been taxed. It would include Roth IRAs or whole life insurance policies.
Obviously, the less tax we pay, the more cash we have available for ourselves, so you want to emphasize as much tax-free income as possible, but you should also have slow-growth, liquid accounts such as money markets or savings accounts, readily accessible for short-term expenses. Your next-best option would be to seek investments that generate qualified dividends and capital gains, because of their comparatively low tax rates. Know that your taxes may account for up to 37 percent of your income (or more if you live in the state which also levies income tax). It’s likely that tax rates will be significantly higher during your retirement than they are now, partially due to the expenditures currently being used to deal with the coronavirus crisis.
These are just the basics when it comes to retirement planning, but everyone’s situation is unique. My point here is that the time to plan for retirement is now, whether you’re young and plan to work for several more decades, squarely in the middle of your career, or rapidly approaching retirement. It’s never too late, but every day you wait to plan is a day you miss an opportunity to put a little more aside.
Arriving at your “magic number” is complicated, and we can help. Sitting down with a CPA can help with forecasting, goal setting and retirement planning, and as a Professional Financial Specialist (PFS), I can assist with this and much more. Contact us today to see how we can help you stop squirming in your chair whenever you hear the word “retirement”!