August 5, 2013 – Published in the North Bay Business Journal
What is your retirement fantasy? Will you travel? Work part-time? Start a second career? Take classes? Write your memoirs?
Most people have some thoughts about how they’d like to spend their retirement years, yet they often have no idea how much they should be saving to make their plans materialize.
We often hear of “safe” spending or withdrawal rates in retirement. One common savings yardstick is to put away 10 percent of your take home pay. Although this may be a great start; it is too simplistic. Each household must analyze their retirement savings plan based not only on their saving time horizon but also on current income, future income, retirement spending, social security income, and investment allocations. Based on how these variables interact, your optimal savings target can be estimated with confidence to make those retirement dreams come true.
Here are some important concepts to remember when putting together your retirement savings plan
- It is very important to start saving early and save consistently year over year. The power of compound interest has a much greater impact if you have time on your side. Start saving early and you’ll have to save less. Also, consistency is actually a more important driver of success than your investment allocation. If your employer has a 401(k) plan, that is one of the best ways to save for retirement as it reinforces the concept of consistently saving every single pay period. You may also get an employer match with your contribution.
- You’ll likely need to save more than you think. If you want a high probability of having a retirement lifestyle similar to your current lifestyle, than you’ll likely need to save between 15 to 20 percent of your gross income from age 25 until you stop working. If you start saving later, than expect to sock away upwards of 25 percent. FYI: This is just for saving for retirement. Saving for your kid’s college, a new car, or a vacation house would entail even more being saved.
- The more you earn today, the more you’ll need later. If you are a high wage earner, your savings percentage rate should be even higher than the average person, for the simple reason that Social Security income will cover less of your relative expenses. For lower wage earners, Social Security covers about 60 percent of preretirement income while higher wage earners only have about 20 percent of Social Security covering their preretirement income. So, if you want to maintain the same quality of life as you currently do working, then you’ll need to save more than the general averages. Between the lowest and highest income range, the savings targets might range from under 7 percent to 28 percent of gross income per year.
- Your income level will change over time and so should your saving target. Individuals just starting their careers really don’t need to save at the average rates upwards of 15 percent as long as they increase their savings percentage as income rises.
Since income is usually less early in one’s career, many young households will spend most of their earnings while at the same time taking on a considerable amount of debt, such as student loans and home mortgages. As income grows to a higher level relative to debt, then it is time to ramp up retirement savings. By its design, a mortgage reinforces a higher savings rate later in life, as you pay more towards principal near the end of the mortgage.
- You’ll likely need more money in retirement than you think. Here is a way to think about this: When do you spend more money, on the weekend or during the workweek? In retirement, you are on one VERY long weekend so you can expect to spend more money. Of course, some of your big expenses while working, will go away once you retire, such as saving for retirement. Your taxes will also decrease. When planning for retirement, be very mindful of how much you’ll really be spending and also know that your spending will likely increase early in retirement on travel and later, on healthcare.
Sometimes looking just at savings target percentages can be a little abstract and often overwhelming when considering how much needs to be saved. The bottom line is to have a plan and execute it with thought and discipline. For many, retirement is a long way off which is both good and bad, and for many there is still time to plan to either ensure you meet your objectives in retirement or at least reduce ugly surprises.
Now is the time to review your savings plan. How much are you saving compared to your household gross income and are you consistently making contributions to retirement accounts? Make sure you are getting any employer matches on a retirement account. Review your investment allocation to optimize your long term goal attainment versus your risk tolerance. Track your progress at least annually. As your household’s income rises, so should your savings percentage.
If any of the above surprises or worries you, the first step to take is to do an accounting of where you stand financially today. Once you get your bearings you’ll then know how to move forward to meet your retirement dreams of tomorrow.