Sunday, November 23, 2008

Are You Ready For Retirement?

Tip #32 - Are you Ready for Retirement? If not, then get ready! Regardless of your age, you should be preparing for retirement. It's never too early. In your 40s? You should be preparing. 35? Not too early. You just turned 21? Perfect time to get started! The idea behind saving early for retirement is that the longer your money is in savings, the more time it has to grow. Also, if you work for 40 years of your life and save a little bit from each year, then you will be able to live on that savings when you're older and not working. If you wait to start saving, then you won't have enough or you will have to put away a lot each year. Start early and you can just put away a little each year. It's like spreading out the cost of retiring over your 40-year or so career.

I just received a brochure from my credit union, Navy Federal about how much I need to save for retirement. It was a real eye opener. I will share highlights of it with you so you can figure out approximately how much you need to retire and how much you should be saving each year. We'll go through an example. There were essentially five steps:

Step 1: Figure out how much income you need in retirement. If you live on $50,000 now, you figure out if you need to live on 75%, 85%, or 95% of your income in retirement. This depended mostly on where you expect to get your healthcare funds from in retirement. Of course these are only estimates. Let's assume 85%. That means you will need $42,500 each year in retirement ($50,000 *.85).

Step 2: Figure out what income you expect to receive in retirement. First calculate how much Social Security you will to get, based on how much you make. A person making $50,000 can expect to get $14,500 per year in retirement from Social Security. Yay, finally you get back some of that money you've been putting into the program all of your working years! You also figure out if you are getting a pension from your employer each year. We'll assume no for this example and whether you will have a part-time job in retirement. We'll assume no again. You can always change your mind on that one. Now we subtract the $14,500 from the $42,500 that we estimate we'll need in retirement. The result is $28,000. This is the amount we will need each year in retirement to live similarly as we do now.

Step 3: How much do we need to save now in order to get to this figure? The worksheet gave us different scenarios of when we expect to retire and how long we expect to live (as if we know!). The earlier you hope to retire and the longer you live means you will need to save more. The later you retire and the shorter you expect to live, the less you need. Let's err on the side of conservative. Better to have too much money than not enough. Let's assume we expect to retire at 65. If we are female and hope to live to the age of 92, we use a factor of 18.79 to calculate the savings we need. Take the $28,000 * 18.79 and we come up with $526,120. That is how much we need total for retirement.

Step 4: Figure out how much savings you have so far and how long you have until retirement. If you are 30 years old now, you have 35 years until retirement at 65. Using their chart you get a factor based on this number of years until retirement. In our example the factor is 2.4. Multipy 2.4 * the amount we have saved so far. Let's assume we haven't been too good about savings yet and we only have $20,000 saved for retirement so far. Multiply 2.4 * $20,000 and we get $48,000. We subtract this from our total needed for retirement in step 3. So we take $526,120 - $48,000 and come up with $478,120. This is our total savings goal. In other words, what we need for retirement.

Step 5: Figure out what our yearly savings should be from now on. We have 30 years until retirement. Using the factor they have in a chart, we multiply .020 * our total savings goal from the last step. So we take $478,120 * .020 and come up with $9,562.40. This is how much we should be saving each year for retirement.

I only gave bits and pieces of this retirement worksheet. But the source of it was the Choose To Save organization from the American Savings Education Council, a program of the Employee Benefit Research Institue Education and Research Fund. The full worksheet is at Choose To Save. Check it out and figure out how much you need to save for retirement.

So in this example we figured out that we need to save a bit over $9,500 per year for retirement. Sounds like a lot, doesn't it? It's essentially $800 per month. There are tax incentives to do this, though. You can save $5,000 per year in an IRA and you can put away the rest through a 401K at work if that's available to you. Regardless of how you save this money, you should keep this figure in mind when doing your budget. Retirement savings should always be a line item on your budget.

In Real Life (IRL) - I have been saving money for retirement since I turned 23. That was a year after I started my first real job out of college. My company offered a 401K plan and said the first 3% of my salary that I saved, they would match! So I saved 3% of my salary. At the time my salary was slightly less than $21,000. So I save about $600 and my company matched it. Altogether my first year of saving was about $1,200. A year or two after that, an older man at work advised me to put the maximum I could into my 401k. He said the money is taken out before you even see it so you don't miss it. So I took his advice and maxed out on my 401k which I believe was 13% of my salary. My company still matched dollar for dollar the first 3%. So essentially 16% of my salary was getting saved each year for retirement. I didn't see the money and I didn't miss it. Even though I was making under $30,000 in those first few years of my career, I was saving almost $3,000 for retirement annually. At some point in my 20's I started putting the maximum amount into an IRA, too.

When I met my husband, he too, had been putting money into his 401(k) at work. But he wasn't contributing to an IRA. I got him started on that and we've both been doing it faithfully since. I am now 41 years old so it is exactly 20 years since I started my first job. I haven't worked more than part-time in the last 7 years. Yet because I started early our retirement savings have accumulated about $300,000. We still expect to have 20 more years until retirement. Based on the worksheet, we still need to be putting away about $10,000 per year until retirement. That's okay. It's in our budget to do so. And retirement savings should be in your budget, too.

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