Start Your Retirement Plan Today
By: Financial Hotline
Fall 2018 (Vol. 36, No. 3)
With longer life expectancies and the growing senior population, it’s time to begin planning and saving for retirement in your 30s or even sooner. However, it is never too late to start or to improve a retirement plan. Basically, there are three steps to retirement planning:
- Estimating your retirement income
- Estimating your retirement needs
- Deciding on investments
Estimating Your Retirement Income
Most people have three possible sources of retirement income: (1) Social Security, (2) pension payments, and (3) savings and investments. The income that will have to be provided through savings and investments (which you can plan for) can be determined only after you have estimated the income you can expect from Social Security and from any pension plans (over which you have little control).
To estimate your Social Security income, you should file a “Request for Earnings and Benefits Estimate” with the Social Security Administration (SSA). This form can be obtained from the SSA by calling their toll-free number: 800-772-1213 or by requesting a benefits statement online through the Social Security Administrations Web Site at www.ssa.gov The amount of Social Security benefits you will receive depends on how long you worked, the age at which you begin receiving benefits, and your total earnings.
If you wait until your full retirement age (65 to 67, depending on your year of birth) to begin receiving benefits, your monthly retirement benefit will be larger than if you elect to receive benefits beginning at age 62. The full retirement age will increase gradually to age 67 by the year 2027.
When you are estimating your after retirement income, don’t forget that Social Security benefits may be subject to income tax. The basic rule is that if your adjusted gross income plus tax-exempt interest plus half of your Social Security benefits are more than $25,000 for an individual or more than $32,000 for a couple, then some portion of your Social Security benefit will be subject to income tax. The amount that is subject to tax increases as the level of adjusted gross income goes up.
Estimate how much you can expect to receive from a traditional pension plan or other retirement plan. If you are covered by a traditional pension plan and you are vested, ask your employer for a projection of what you can expect to receive if you continue working until retirement age or under other circumstances, for example, if you terminate before retirement age.
If you are covered by a 401(k) plan, a profit-sharing plan, a Keogh plan, or a Simplified Employee Pension, make an estimate of the lump sum that will be available to you at retirement age. You may be able to get help with this estimate from your employer. If you are in the military or formerly served in the military, contact the relevant branch of service to find out about retirement benefits.
Establishing Goals For Retirement
First you need to determine how much income you will need in retirement, then you will use that number to figure out how much you need to put away to reach your goal.
A general guideline is that you will want to have at least 70 percent of whatever income stream you have before retirement. If you have any special needs or desires, for example, a desire to travel extensively-the percentage should be adjusted upward. The 70 percent figure is not a substitute for a thorough analysis of your income needs after retirement, but it is a good rule of thumb to start with.
Here are some suggestions to help you customize your estimate:
The first step in trying to figure out what your annual expenses will be after retirement is to figure what your expenses are now. Take a year’s worth of checkbook, credit card, and savings account records, and add up what you paid for insurance, mortgage, food, household expenses, and so on.
Next, estimate how your expenses will change after retirement. Here are some questions you might ask yourself:
- Will your mortgage be paid off?
- Will you still be paying for commuting expenses?
- How much will you pay for health insurance? Note: If you won’t have post-retirement health insurance coverage from an ex-employer, you may pay more for health coverage after you retire.
- Will you need to increase or decrease your life insurance coverage?
- How much will you pay for travel expenses? (Do you want to travel after you retire, either on vacation or to visit relatives? Will you be commuting between a winter and summer home?)
- Do you plan on spending more on hobbies after retirement?
- Will your children be financially independent by the time you retire, or will you have to factor in some sort of support for them?
- Will your income tax bills be the same, lower, or higher?
The answers to these questions will help you determine your estimated annual expenses after retirement. Then subtract from this estimate the anticipated annual income from already-viable sources. (Do not subtract the lump-sum payments you expect to receive, for example, lump sum payments from 401(k) plans) The difference is the annual shortfall that will have to be financed by the nest egg you will need to accumulate.
Once you have your estimate, you can use a table like the one below to determine how much you need to save each year to accumulate your goal nest egg by retirement age. (This one assumes an after-tax return of 5 percent per year) Just multiply the required nest egg by the Savings Multiplier for the number of years until retirement.
Example: You are 40 years old and want to retire at age 65. You determine that you need a nest egg of $350,000 to fund your annual shortfall. To find out how much you must save each year to have that $350,000 nest egg by the time you are 65, multiply $350,000 by the 25- year savings multiplier (2.1 percent). You will need to save $7,350 (2.1 percent times $350,000) a year for 25 years. Subtract from this nest egg any lump sums that you expect to receive at retirement. To project the value at retirement of a present asset (retirement account, savings, investments, etc.); multiply the current value of this asset by the Growth Multiplier for the number of years until retirement.
Example: You already have $75,000 in a 401(k) plan. To find out what that amount will grow to in 25 years, multiply it by the growth multiplier for 25 years. This $75,000 will grow to $254,250 (339 percent times $75,000) by the time you retire. Subtract this $254,250 from the $350,000 needed in the previous example. This amount ($95,750) is the amount you must accumulate by age 65 to meet the income shortfall. Multiply this $95,750 by the 25-year savings multiplier (2.1 percent). You now know that, after taking the projected lump sum into consideration, you will still need to save $2,010.75 per year to accumulate $95,750.
| Years Until Retirement | Savings Multiplier | Growth Multiplier |
|---|---|---|
| 5 Years | 18.1% | 128% |
| 10 Years | 8.0% | 163% |
| 15 Years | 4.6% | 208% |
| 20 Years | 3.0% | 265% |
| 25 Years | 2.1% | 339% |
| 30 Years | 1.5% | 432% |
Deciding on Investments
Generally, the longer you have until retirement, the more of your savings should be invested in vehicles with a potential for growth. If you are very close to or at retirement, you may wish to put the bulk of your savings into low-risk investments. However, this formula is subject to your own fi nancial profi le: your tolerance for risk, your income level, your other sources of retirement income (e.g., pension payments), and your unique needs.
Here is a summary of the pros and cons of various retirement-savings investments and their pros and cons.
Tax-Deferred Retirement Vehicles
Each year, maximize your deposits in a 401(k) plan, an IRA, a Keogh plan, or some other form of tax-deferred savings. Because this money grows tax-deferred, returns will be greater. Further, if the amount you put in is deductible, you are reducing your income tax base.
Lowest Risk Investments
Money market funds, CDs, and Treasury bills are the most conservative investments. However, of the three, only the Treasury bills offer a rate that will keep up with infl ation. For the average individual saving for retirement, it is recommended that these vehicles make up only a portion of investments.
Bonds
Bonds provide a fi xed rate of income for a certain period. The income from bonds is higher than income from Treasury bills. Bonds fl uctuate in value depending on interest rates, and are thus riskier than the lowest risk investments. If bonds are used as a conservative investment, it is a good idea to use those of a shorter term, to minimize the fl uctuation in value that might occur.
Stocks
Although common stock is riskier than any other investment yet discussed, it offers greater return potential.
Mutual Funds
Mutual funds are an excellent retirement savings vehicle. By balancing a mutual fund portfolio to minimize risk and maximize growth, a higher return can be achieved than with safer investments.