Everyone agrees that saving and investing for retirement is essential, but the more difficult question is: How much should you save for retirement? It’s a difficult question because nobody can really provide a one-size-fits-all answer or even a general across-the-board guideline.
Everyone has different goals, wants, and needs, so everyone’s retirement will look different from everybody else. The right amount to invest for retirement is determined by what you want to do in retirement, how much you have saved now, and how many years you have left before you retire.
These three criteria seem fairly straightforward, but they are difficult to determine. Many people get it wrong, with disastrous results. Working with a fiduciary financial advisor can dramatically help determine how much you need to set aside for retirement. This blog post will provide a high-level guide to help you move in the right direction.
Key Takeaways
- Determining your retirement financial goals is essential. You should consider your envisioned lifestyle, future expenses, increasing lifespan, and pitfalls such as healthcare costs and inflation's impact on purchasing power.
- Evaluating and diversifying retirement income sources is critical. Carefully consider Social Security timing, pension and annuity income, and the potential for part-time work to supplement savings and provide mental benefits.
- The key to finding how much to save for retirement depends on several factors, and your ultimate success will depend on which tools you use, how disciplined you are in following your retirement plan, and how diligent you are in reviewing the plan and your situation over time. Utilizing the expertise of a fiduciary financial advisor will go a long way in planning for retirement.
Determining Your Retirement Financial Goals
Retirement planning is a lot like a sailing trip. It is a journey that takes some time to complete and rarely represents a straight line from start to finish. Like sailing, you must tack back and forth, veering a bit from one side to the next as your circumstances, employment, and the overall economy change over time.
Planning for retirement also requires meticulous preparation and a clear destination. You probably won’t get there if you don’t know where you’re going. Consider the lifestyle you live right now. What are your living expenses? What are your sources of income? Are you right on the edge, or do you have a lot of margin for error?
Now, consider how that will change. You’ll probably eliminate some expenses in retirement. The ones you keep will typically grow as inflation increases the cost of living. You might also add expenses depending on what dreams you want to pursue in retirement. Will you be sailing around the world, penning the next great novel, running marathons in exotic locations, or traveling regularly to watch the grandkids grow up? Your goals and dreams come with varying price tags; you must understand each choice’s financial implications.
It’s about balancing dreams with pragmatism. We all can dream big, and that’s great. But that’s the beginning of the process. From there, most of us must give up some of the bigger “pie-in-the-sky” dreams to accomplish the others. Dream big to begin, but then prioritize and balance expectations with a reality you can achieve.
With clear financial goals established, you can estimate your retirement costs and lifestyle. This information can help you determine how much you’ll need in retirement savings to afford your desired retirement lifestyle. As you move toward retirement, it’s essential to measure your progress to ensure that your retirement nest egg is sufficient and remains so during your actual retirement.
Remember, the goal is not just to retire but to retire well. Your retirement plan must honestly consider your age and life expectancy. With life spans increasing, some of us might spend as many as 40 years in retirement, making early and efficient planning non-negotiable.
Lifestyle Aspirations and Cost Implications
What does your ideal retirement really look like? Is it hanging out in a small country cottage with a modest lifestyle and lower living expenses? Is you goal to retire in an expensive state like California? Is it simply staying where you are, enjoying hobbies you couldn’t fully embrace during your working years? Is it a more expansive and expensive vision with world travel, luxury cruises, and gourmet dining?
Your savings strategy must reflect a realistic assessment of the expenses these choices incur. The key is to align your expected retirement income with a desirable and financially viable lifestyle.
We painted a fairly broad spectrum of retirement visions, and it’s natural to want the most expansive and expensive dreams you’ve ever entertained. But just like the little kid who says they want to be a fireman, astronaut, or professional athlete, we must jettison the unrealistic dreams.
Sometimes, trimming your sail and making these adjustments is easy; other times, it requires making some tough decisions to ensure your retirement years are comfortable and secure. You do not want to create more worries and stress in retirement.
Estimating Healthcare Costs
Don’t overlook healthcare costs as you craft your realistically achievable retirement vision. Healthcare is one of those costs we can take for granted, and substantial increases can often surprise you. One of the consequences of living longer is unexpected substantial increases in healthcare costs. These expenses often represent a substantial portion of the retirement budget, including premiums, supplemental insurance, and out-of-pocket costs.
If you’ve been generally healthy most of your life, you may not anticipate what these increases can look like. They quickly add up. It’s not just the predictable costs like insurance premiums and prescription medications that need consideration but also the potential for substantial expenses that Medicare does not cover, such as certain deductibles and long-term care.
The fear of depleting savings due to unforeseen health issues is common among retirees, and for good reason. Unexpected medical bills can be a significant financial burden, making prudent planning and safeguarding one’s future well-being essential.
Inflation and Its Effect on Retirement Savings
Inflation is one of the silent killers that can devastate your retirement savings. Inflation silently erodes your retirement savings’ purchasing power. As pointed out, the average American will spend 20+ years in retirement. That’s a vital timeframe to keep in mind. Your savings have to last 20+ years, not just 3 or 5. The average inflation rate in the U.S. since WWII ended is roughly 3%. Over 20+ years, 3% will decrease your purchasing power by 50%. That is not an exaggeration. At 3% inflation, $500,000 will need to be $1 million in 20+ years just to maintain the same lifestyle.
Inflation is a “silent” killer because it happens so gradually. $100 today costs $103 next year; nobody really notices. Then $103 becomes $106, then $116 in 5 years. By the time you hit 20 years, you need $200 just to buy the same stuff that $100 used to buy. To stay afloat, you need to adjust your retirement savings goals to account for these rising tides.
Set your expectations properly to avoid disaster. Anticipate these higher future expenses to ensure that your savings are sufficient to maintain the lifestyle you’ve worked so hard to achieve. Saving money is insufficient; you must save smart to outpace inflation and protect your financial future.
Evaluating Income Sources in Retirement
How much you should save for retirement is also determined by the desired annual retirement income sources you’ll have. There are several different sources that have typically helped retirees cover their retirement living expenses. The primary sources include:
- Social Security
- Pensions
- Annuities
- Proceeds from selling home
- Inheritance
Social Security Benefits and Timing
Social Security can be a valuable source of additional retirement income, but it was never designed to cover 100% of your living expenses in retirement. When originally created, projections indicated that the average American adult worker would live until age 65 and could start receiving social security benefits at age 62. Even from the start, Congress only intended it to cover a few years.
Today, after having been amended several times, the program is now designed to replace roughly 40% of your pre-retirement earnings. The average retiree should not rely exclusively, or even predominantly, on future Social Security benefits. You’ll need to supplement these benefits with other income streams to fully sustain your retirement living standard.
Even if you know you have to supplement your Social Security benefit, you need to be wise in claiming your benefit. Claiming benefits before reaching full retirement age (FRA) is tempting, but it permanently reduces monthly benefits. Full retirement age is 66 or 67, depending on when you were born. You can claim your Social Security retirement benefit as early as age 62. Still, workers born in 1960 or later will see a 30% reduction in their full retirement monthly benefits if they claim Social Security at age 62.
But you can also delay benefit payments beyond your full retirement age. If you wait until age 70 to receive benefits, your monthly benefit payment will be even more significant. For late savers, postponing retirement can be a strategic move to bolster savings and enhance Social Security benefits.
Pension Income and Annuities
Pensions and annuities are similar to Social Security benefits because both can provide a consistent monthly benefit for as long as you live. Some employers offer pensions, and the employer determines the pension benefit within general regulatory guidelines. Annuities are insurance products that promise to pay you a lifetime monthly benefit for life or some number of years. Each annuity contract is unique and usually purchased directly from the insurance company.
Both pensions and annuities promise a guaranteed income for life, helping to cover some basic expenses during retirement. We offer an extensive guide to understanding annuities, but if you already have a pension or an annuity, make sure you pick the right payment option to fit your retirement needs.
Generally speaking, the options are:
- Payments for your lifetime
- Payments for your lifetime and/or your spouse's
- Payments for a set number of years (e.g., 10, 15, 20, etc.)
- Payments for a combination of life or a set number of years
We cannot emphasize enough how vital this payment decision is. Please consider using a fiduciary fee-only financial advisor to determine which option is best for you and how it will affect the amount of retirement savings you’ll need.
Home Proceeds And Inheritances
Most pre-retirees do not want to count on the equity in their home or in receiving a sizeable inheritance. That’s a wise approach since it’s difficult to plan what your home will be worth, what your replacement home will cost, and/or what your parents, grandparents, aunts/uncles, etc., will leave you as an inheritance. But if you do know what the net house proceeds or inheritance will be, then this should complement, not replace, your retirement savings goal. Perhaps we’re being too cautious, but we’ve seen several clients who “knew” what they would receive, only to be sadly disappointed as they entered retirement.
Earning Potential After Retirement Age
Another issue to consider is whether you want to work part-time during retirement. Today’s active retiree is not just playing golf seven days a week. Many retirees take on a part-time gig in a job they really love. Those extra earnings for those extra years – however long you want to keep working – supplement your retirement savings.
Beyond providing supplemental annual income, part-time work offers mental benefits, keeping you active and socially engaged. A gradual transition into retirement through part-time work can ease you into a new lifestyle, mixing the benefits of leisure with the fulfillment of productivity.
The Role of Retirement Accounts in Saving
After considering the issues above and determining how much to save for retirement, you should consider the different types of accounts you can use to store and grow your retirement savings. “Retirement” accounts come in different shapes and sizes. Picking the right one(s) can help or hinder your progress.
This is a complicated issue and one that also deserves the attention of a fiduciary advisor, but by way of a quick summary, the primary differences among the available tax advantaged retirement accounts center around the contribution limits, potential employer participation, and the tax treatment of each one.
Employer plans, such as 401(k)s, Profit-Sharing Plans, and SEPS, allow or require the employer to make contributions. You can also contribute to many of these plans. The maximum annual contribution amounts can be sizeable, and these accounts go a long way toward supercharging your retirement savings.
Traditional IRAs only allow you to make contributions, and the maximum annual contribution amount is fairly limited. If you have access to an employer-sponsored plan, the odds are high that this is the best place to start making contributions.
Roth accounts are another retirement account, and there are two forms: a Roth IRA and a Roth 401(k). Similar to the discussion above, there are significant differences in the contribution limits between these two.
The primary difference between regular retirement savings accounts (IRAs and 401(K)s) and Roth accounts (Roth IRAs and Roth 401(K)s) is the tax treatment, which the tax section below discusses. Depending on your stage of life and retirement timeline, one or the other will be a better tool.
Catch-Up Contributions
While we referenced above the different contribution limits for the various retirement accounts, remember that if you are 50 or older, you may also be eligible to make a “catch-up” contribution. Catch-up contributions are additional amounts you can make because you are close to retirement. For those 50 and above, catch-up contributions can really goose up your retirement savings and may provide additional tax breaks.
Understanding Tax-Deferred and After-Tax Contributions
There are three stages of taxation that affect retirement accounts: the contribution stage, the growth stage, and the withdrawal stage. Here’s a quick summary of how retirement accounts are taxed in each phase.
Regular Retirement Accounts (IRAs & 401Ks):
- Contributions are tax deductible
- Growth in the account is not taxed
- Withdrawals are taxed
Roth Retirement Accounts (Roth IRAs & Roth 401Ks):
- Contributions are not tax deductible
- Growth in the account is not taxed
- Withdrawals are tax-free
Depending on your stage of life and the tax rates you face now compared to those you would face when you retire, the difference in tax treatment will profoundly affect your retirement savings and success.
Choosing the right retirement vehicle to invest for retirement is not an easy decision, and you should analyze your options carefully to make the best decision. A fiduciary advisor can provide 100% objective analysis and advice on your best option.
How Much of Your Salary Should You Save?
A pivotal question in the whole process is: how much of your pre retirement annual income should you contribute to your retirement savings? While a general rule of thumb is to set aside 10% to 15% of your income, including employer contributions, the exact amount you should put aside depends on several factors, such as:
- Your age
- Expected retirement age
- Anticipated lifespan
- Lifestyle you wish to maintain
The tendency is to latch on to a general rule of thumb like this without really determining whether it truly fits your unique situation. Another frequent mistake is to “set it and forget it.” Even if you determine the right savings rate today, it will probably be different in the future as your situation changes.
Adjusting Savings Rates Based on Current Financial Status
As your financial situation changes, so too should your savings rate. As the years progress, your income and lifestyle change and your retirement savings will hopefully grow. You’ll be in a different place tomorrow than you are today. Your goals may also change, and you may find that you have competing goals – saving for retirement vs. saving for a second home or wedding, etc.
The point is that your savings rate needs to adjust over time to keep you on track to a successful retirement, and you need to review your retirement savings balances and savings rate periodically.
The Right Retirement Savings Level For Your Retirement
The right retirement savings level for your retirement depends on several factors we’ve discussed above, and your ultimate success will depend on which tools you use, how disciplined you are in following your retirement plan, and how diligent you are in reviewing the plan and your situation over time.
There are many factors, but there are also many unknowns. We highly recommend engaging a financial planner to help you with this. It’s important enough that you should not try to develop your retirement plan by yourself.
But you shouldn’t use just any financial advisor. Too many of them offer “advice” and are really just trying to sell you one financial product or another. Insurance sales reps, annuity sales reps, commission-driven stock brokers, and a host of others will offer advice. Some may even charge you for it, furthering the illusion that they are helping you when, in fact, the point is to sell you something.
You do have an option, though. Fee-only, fiduciary financial advisors are legally and morally obligated to act solely in your best interest. Like a CPA or an attorney, they charge a reasonable fee for their services to help you develop a strong retirement plan and keep you on track over the years. They do NOT sell any product; they do NOT take any commissions; they do not in any way compromise their 100% objective approach to providing sound advice.
Solid financial advice is estimated to make a positive 3% per year difference in your retirement savings. That 3% difference over roughly 20 years can mean a 100% difference in the size of your retirement savings. By way of an example, that means if working without a good advisor will build a $1 million savings nest egg, then working with a good advisor could build a $2 million savings nest egg.
We at First Financial Consulting have provided fee-only advice as a fiduciary for more than 45 years. We never compromise our objectivity, and we focus on helping our clients achieve their retirement goals and dreams.
We’d love to connect with you to see how we can help you on your journey. Give us a call, send us an email, or use the button below to request a free initial consultation. Building the right retirement savings begins now.
Greg Welborn is a Principal at First Financial Consulting. He has more than 35 years’ experience in providing 100% objective advice, always focusing on the client’s best interests.
Greg Welborn is a Principal at First Financial Consulting. He has more than 35 years’ experience in providing 100% objective advice, always focusing on the client’s best interests.
