If you\u2019re like most of us, you may be looking at retirement with a mix of anticipation and trepidation.\u00a0 It may be decades away, or it may be right around the proverbial corner.\u00a0 During your working career, you\u2019ve probably been diligent about saving to buy a home, have a family, pay for your kids\u2019 college, and for retirement.\u00a0 For many, these can be competing goals.\u00a0 How much should you save for each?\u00a0 And for retirement, how much will you need to have saved to be comfortable and secure?\u00a0 After all, running out of money is one of the top retirement concerns for most Americans.<\/p>\n
It may seem obvious, but if you don\u2019t know how much you\u2019ll want to spend in retirement, it\u2019s hard to say how much you\u2019ll need to save during your working years.\u00a0 So, the first step in making sure you won\u2019t outlive your retirement savings is to get a financial plan.<\/p>\n
A robust financial plan will include all of your financial goals \u2013 think of them as \u201cneeds\u201d, \u201cwants\u201d, and \u201cwishes\u201d \u2013 ranked by priority.\u00a0 Your \u201cneeds\u201d would include your core, or essential, living expenses \u2013 things like housing, utilities, food, and other expenditures that don\u2019t change much from year to year \u2013 while your \u201cwants\u201d and \u201cwishes\u201d might include variable expenses like vacations, periodic upgrades to your home, replacement cars, and charitable giving, for which you have some flexibility around when you incur them. Your financial advisor should be able to help you look at your current spending, categorize it, and project it into the future.<\/p>\n
Once you have a good sense for your current and projected spending, you and your advisor can make some assumptions about future inflation (which will reduce the value of your savings), investment returns (which will grow your current and future savings), tax rates and, perhaps most importantly, your planning horizon (or life expectancy).<\/p>\n
With a set of realistic assumptions and a clear picture of your desired spending, you\u2019ll be able to determine a \u201csafe\u201d withdrawal rate for your retirement savings.\u00a0 A \u201csafe\u201d withdrawal rate is one that will allow you to take a certain amount out of your portfolio in the first year of retirement, increase that amount each year to keep up with inflation, and be very confident that your portfolio won\u2019t be depleted over your lifetime.\u00a0 By calculating and sticking to a safe withdrawal rate, you can minimize the likelihood that you\u2019ll run out of money \u2013 a key retirement concern for many.<\/p>\n
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For an American with average earnings, Social Security<\/a><\/strong> will replace only about 40% of their pre-retirement income. For higher income earners, this percentage is lower, while for those with lower than average incomes it\u2019s higher.\u00a0 So, since most of us no longer receive defined benefit pensions from our employers, it\u2019s important that we save and invest to build a nest egg that can provide additional income in retirement to supplement Social Security.<\/p>\n \u201cSave early, save often\u201d, so the saying goes.\u00a0 The implication is that you start saving as early as you can, and that you should save as much as possible.\u00a0 Why?\u00a0 Because of the \u201cmagic\u201d of compounding<\/a><\/strong>.\u00a0 Compounding is what allows even small amounts of money that you save to grow into a large sum, given enough time.\u00a0 The money you save \u2013 in a savings account, a retirement account, or an after-tax investment account \u2013 earns a return.\u00a0 Over time, your account will generate earnings on your old and new contributions, as well as on past earnings you\u2019ve accumulated (\u201cearnings on earnings\u201d).\u00a0\u00a0 As your savings grow, you generate earnings on a bigger and bigger pool of money.<\/p>\n By way of example, let\u2019s say you want to save $1 million for retirement at 65, and assume you\u2019ll earn 7% per year on your investments.\u00a0 If you start saving at age 20, you\u2019ll only need to save about $264 a month.\u00a0 But if you wait until age 45 to start saving, you\u2019ll need to set aside over $1,900 a month to reach that $1 million nest egg by age 65.<\/p>\n While few Americans today enjoy defined benefit pensions<\/a><\/strong> for their retirement, there are still some tax advantages available to you.\u00a0 Most companies sponsor defined contribution retirement plans (like 401(k) and 403(b) plans).\u00a0 Defined contribution plans allow you to defer a portion of your salary into a retirement account, and to defer taxes on the growth in your account until you decide to begin taking distributions in retirement.\u00a0 Many of these plans include matching and\/or profit-sharing contributions from the employer.<\/p>\n If your employer doesn\u2019t sponsor a retirement plan, you should still save in a Traditional and\/or Roth Individual Retirement Account.\u00a0 And if you\u2019re self-employed, you can set up your own \u201csolo\u201d 401(k) plan at almost any bank or financial services company.<\/p>\n As important as how much you save, is how<\/u> you invest your savings.\u00a0 You should make sure that your portfolio takes enough investment risk to enable you to meet your goals, but not so much that the periodic fluctuations in the value of your investments cause you to lose faith, panic and abandon your investment strategy at the worst possible time.\u00a0 Your asset allocation<\/a><\/strong> \u2013 the broad mix of investments \u2013 should be appropriate for your investment horizon, risk tolerance, and other unique goals and constraints.\u00a0 Your portfolio should be well-diversified<\/a><\/strong> across a range of \u201casset classes<\/a><\/strong>\u201d, and well-diversified within<\/u> those asset classes.\u00a0 Proper diversification will improve the risk\/return relationship for your portfolio.\u00a0 You should use investments that are low-cost and tax-efficient.\u00a0 For most investors, that means mutual funds and exchange-traded funds, rather than individual stocks and bonds.\u00a0 And you should pay attention to asset location in your portfolio \u2013 ideally, holding investments that pay regular taxable distributions (i.e. bonds and real estate investments) in a tax-deferred retirement account, and investments that generate most of their return from capital appreciation (i.e. stocks) in a taxable account.<\/p>\n If you construct your portfolio of retirement and investment accounts properly, you can give yourself the best possible chance of accumulating a solid retirement nest egg, which is a top retirement concern for many investors.<\/p>\n Unfortunately, many Americans will have to rely on Social Security for the bulk of their retirement<\/a><\/strong><\/span> income.\u00a0 And, as we noted before, for someone with average earnings, Social Security will only replace about 40% of their pre-retirement income.<\/p>\n The Social Security program was established in 1935.\u00a0 Social insurance, as conceived by President Roosevelt, would address the permanent problem of economic security for the elderly by creating a work-related, contributory system in which workers would provide for their own future economic security through taxes paid while employed.<\/p>\n The age at which you can claim your full Social Security benefit \u2013 known as your Full Retirement Age, or FRA \u2013 is increasing gradually because of legislation passed by Congress in 1983. Traditionally, the full benefit age was 65, and early retirement benefits were first available at age 62, with a permanent reduction to 80% of the FRA amount. Currently, the full benefit age is 66 years and 2\u00a0months for people born in 1955, and it will gradually rise to 67 for those born in 1960 or later.<\/p>\n Importantly, it\u2019s also possible to delay taking your Social Security benefit beyond your FRA, to as late as age 70.\u00a0 For each year that you delay taking your benefit, your payment will increase by 8%.\u00a0 So, for someone born in, say, 1964 and whose FRA is therefore age 67, if they wait until age 70 to begin claiming, their benefit will be 24% higher.<\/p>\n Of course, if you delay taking your FRA benefit at 67 until age 70, you\u2019ll miss out on receiving benefit payments for three years.\u00a0 This means that you want to be reasonably sure that you\u2019ll live long enough for the value of your delayed, higher benefits to be greater than that of the missed (lower) benefits.\u00a0 In most cases, that \u201cbreak-even\u201d age is about 84.<\/p>\n And, if you retire before you begin taking your delayed Social Security benefits, you\u2019ll need other savings to provide you with income until your higher benefits kick in.\u00a0 But, all things considered, if you think you\u2019ll live well into your 80s, waiting to claim Social Security until age 70 can provide you with a significantly higher benefit, and more guaranteed income \u2013 which is a key retirement concern for many.<\/p>\n Many Americans, including many of our clients at Springwater, are living long, healthy lives.\u00a0 It\u2019s quite possible that you\u2019ll live longer than the average American, longer than your parents did, and perhaps longer than even you might have thought possible.<\/p>\n But living longer brings with it two financial challenges \u2013 the possibility of needing care later in life, at home or in a facility, and the possibility of outliving your resources.\u00a0 Fortunately, both of these retirement concerns can be addressed in the context of a robust financial plan.<\/p>\n Paying for long-term care costs can be a significant drain on your financial resources.\u00a0 So, this may be a risk that you want to insure against, particularly if there\u2019s a history of needing care in your immediate family.\u00a0 It\u2019s possible to buy long-term care insurance, which will pay you a benefit to help defray these costs, as soon as your doctor indicates you need help with activities of daily living<\/a><\/strong>.<\/p>\n If the cost of long-term care insurance seems unattractive, and you have other resources to pay for the cost of care, you may elect to \u201cself-insure\u201d.\u00a0 In this case, you\u2019ll want to make sure that you mentally set aside the financial resources you may need, or consider an alternative like accessing some of the equity in your home through a home equity conversion mortgage (or \u201creverse mortgage\u201d).\u00a0 And you\u2019ll want to incorporate the cost of care, and the resources needed to pay for it, into your financial plan.<\/p>\n Even if you\u2019re fortunate enough to never need care, it\u2019s possible that you could simply live much longer than you, or anyone else, anticipated.\u00a0 The number of Americans age 100 or older is about 50% higher today than it was just 20 years ago.<\/p>\n\n
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If You Can, Consider Delaying Taking Social Security<\/h2>\n
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Insure Against These Two Risks<\/h2>\n
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