Up until the late 19th and early 20th centuries, there was no such thing as formal retirement. Because people had lower life expectancy, for the most part folks simply worked until they died. On average people only lived to be between 26 and 40 years (1), thus could work without the physical diminishments that old age brings. Since there was no form of pension or social security only wealthy individuals could afford not to work. As medical advances were made, people started living longer, necessitating the need for some type of financial care once they were too old to work. In 1889, Germany’s Chancellor Otto von Bismarck answered this quandary by creating the first old-age social insurance program. Thus entered the era of allowing people to stop working at a specified age a.k.a. retirement.
Retirement planning has seen many ups, downs, and changes since the Chancellor introduced it over 120 years ago. Today, citizens of the United States will need to arm themselves with a lot of useful information and a strategic plan if they want to enjoy financial independence in their golden years. Before we explore how to prepare for retirement, step one is understanding how much retirement money will be required. A 2014 study by the Bureau of Labor Statistics found a household aged 64 – 74 will need an approximate average of $44,680 to live annually. Below are the Bureau’s figures:
• Housing: $15,838
• Transportation: $8,338
• Food: $6,303
• Healthcare: $5,956
• Entertainment: $2,988
• Other: $5,257
Realistically, the costs of living (and retiring) will continue to increase. While these numbers give an idea of necessary retirement funds, a better rule of thumb may be based on requiring 80 to 100 percent of the final working year’s salary. Using this rule, an individual making $100,000 in the last year of employment, would need at least $80,000 a year thereafter to retire in the lifestyle they are accustomed to. Of course, the amount needed varies from person to person based upon financial goals and retirement lifestyle choices. Using the yearly retirement funds needed as a factor, calculate by the number of years one expects to be retired. In other words, how long will someone live after they’ve stopped working. That is always a guess, but be sure to include family history and individual health in the equation. For example, if both parents and grandparents lived to their mid-eighties, and that healthy individual retires at 67, he/she should plan on needing around 20 years of retirement income. Using the Bureau of Labor Statistics’ $44,680, that would come to almost $900,000 for total retirement funding. In other words, the money you withdraw from your retirement fund each year will have a distribution rate of about 4 to 6 percent.
Once the total retirement amount needed has been estimated, it is time to start working toward that goal. Needless to say, the younger someone starts preparing for retirement, the better. But before aiming to build retirement funding, two important topics should be addressed. The first issue is credit card debt. Trying to save for retirement while paying high amounts of interest on credit cards is akin to bailing a thimble of water from a sinking ship filled with holes. The other important item that should be considered is creating an emergency fund. Having three to six months of living expenses set aside for an emergency can make all the difference should something financially unexpected happen. Once you’ve built that amount, make sure to maintain it as living expenses increase. Then forget about the fund, after all, it should only be used for an emergency.
Now it’s time to examine how much will have to be saved to retire. Social Security, as it stands today, will most likely only supplement 20 to 30 percent of the needed monies. Visit Social Security’s online benefit calculator to get a quick estimate of your monthly benefit amount. Defined benefit plans, like pensions began evaporating in the 1980s and today are rarely offered. This means the lion’s share of retirement funding will come from personal savings. 401k contributions may include an employer match, but a Bureau of Labor Statistics National Compensation survey performed in 2015 found the median match is 3.5 percent. Another bleak statistic from the study found that only 56% of employers offered a 401k. To avoid a funding shortfall, future retirees will need to plan on funding about 70 percent of retirement themselves.
Saving for 70 percent of one’s retirement can be a daunting task, but with sound strategies and self-discipline, it can be done. Creating and adhering to a budget is an important factor. Budgets force us to look at what we must spend versus what we want to spend. Things like rent, food, credit card payments, and medical expenses are budget mandatories. Other things such as clothing, vacations, and entertainment can be important to living a happy life, but not necessarily a mandatory. Look for ways to cut unnecessary expenses. Perhaps consider taking a vacation that you can drive to instead of purchasing an expensive airline ticket. While that stunning Gucci purse is on sale, is dropping a few hundred dollars really necessary or can you make due with last year’s style? A gym membership is great for staying in shape, but bicycling to work can burn just as many calories and is free. Years into the future, when ready for retirement, you probably won’t even remember that Gucci purse.
The money saved by paying down credit cards and observing a budget can and should be diverted to retirement savings. There are many forms of retirement savings, ranging from 401ks to Individual Retirement Accounts (Traditional IRA or Roth IRA) to Health Savings Accounts (HSA). 401ks, even without an employer match offer multiple benefits and should be considered when available. An IRA and Roth IRA are other options to consider when a 401k is not available. Another meaningful way to save, that is often ignored is an HSA. Health Saving Accounts are offered in conjunction with a High Deductible Health Plan (HDHP). HSA/HDHPs are an excellent opportunity to work toward building for retirement, particularly when started at a younger age. Preparing for retirement can be confusing, scary, and overwhelming. Therefore, it may be a good idea to seek the advice of a retirement advisor or take advantage of employer sponsored financial wellness programs. Remember, planning for retirement today may help ensure the golden years are indeed the best ones of your life.
Traditional 401(k) and IRA distributions taken prior to age 59 1/2 may be subject to a 10% penalty tax, in addition to ordinary income tax; minimum distributions required at 70 1/2; exceptions to 10% penalty may apply. Roth IRA distributions are allowed provided certain conditions are met; no minimum distributions required at age 70 1/2.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended as authoritative