Saving for Retirement
When the Social Security retirement income system was created in the 1930s, it was designed to provide a partial retirement income supplement. Today, the average Social Security retirement benefit is approximately $1,250 per month, or $15,000 per year. The amount of annual living expenses not covered by Social Security or income sources such as a pension or rental income is often referred to as your “income gap.” If you start your retirement benefits at age 62, your monthly benefit amount may be reduced by as much as 30%. Thanks to what the Social Security Administration calls “delayed retirement credits,” benefits increase 8% each year you delay receiving Social Security—up to age 70. So waiting until you reach age 70 means as much as a third more income for life.
Retirement: How much can I spend?
Once the “income gap” has been determined, the next step is to determine if your accumulated or projected assets are adequate to fill this gap. The goal is to determine the amount of annual living expenses that must be covered by your investable assets such as IRAs, savings and personal investments.
When this goal amount is divided by the size of your investable asset portfolio, the result is the rate of return you need to achieve. For example, if a person’s retirement income needs are $40,000 per year and they receive $20,000 in social security benefits, then their income gap is $20,000.
$40,000 income needs for year
– $20,000 social security benefits
= $20,000 income gap
Assume they have a total investment portfolio of $500,000 that consists of an IRA, CDs and savings as well as some personal investments. Their portfolio will need to return 4% per year to match their annual need.
$20,000 income gap/$500,000 investment portfolio = 4% annual target rate of return.
Retirement: How much will I need to save?
Experts suggest that you will need 75-85% of your pre-retirement income to maintain your lifestyle throughout retirement. What changes in retirement to allow for this 15-25% decrease in your income? Ideally, your mortgage and other debts are paid off. If you have children, they are grown and living on their own. If this is not the case, your income replacement may need to be higher. Another change in retirement that may allow you to live on 75-85% of your pre-retirement income is that you are no longer “paying” into social security (a 7.65% tax on your wages!), and the “expense” of saving for retirement has come to an end. To achieve your retirement goal, you may need to accumulate savings and investments of 10-12 times your pre-retirement annual income. To accumulate this amount of savings and investments, you should save at least 10-15% of your income every year.
Retirement: The power of compounding.
Compounding transforms your working money into a state-of-the-art, highly powerful income-generating tool. When your investments generate earnings, those earnings are added to your account and reinvested. Now you have a larger pool of invested money—your contributions plus your earnings—and the opportunity to generate even more earnings on those invested funds.
Increasing the amount you are contributing increases the potential benefit you may realize from compounding. The longer your money is invested, the more you may benefit from the power of compounding. Years of regular savings and contributions, investment earnings, and compounding can help you build the balance you’ll need to see you through your retirement years.
Retirement: Starting early is essential
Let’s assume Joe saves $100 a month for 30 years beginning at age 35. Michelle also saves $100 a month, but only saves for 10 years beginning at age 23. Both Joe and Michelle earn an average of 8% and plan on retiring at age 65.
Who will have more in their retirement account? Michelle’s balance at age 65 will be $236,000 compared to Joe’s balance of $149,000. Why? Because of the impact of compounded earnings! Even though Michelle contributed less, she started early and received the benefit of compounded earnings on her investments