Putting together a budget and savings plan is undeniably a pain. No one wants to sit there for hours shuffling little bits of paper to calculate how much you spend, how much you earn, and how much you can afford to save. And so many people simply put this chore off, failing to save and thereby dooming themselves to an underfunded retirement.
Painless retirement planning
It's better to save something than nothing, so if coming up with a precise retirement plan is a deal-breaker for you, the next best option is to fall back on a simplified retirement plan. This system will work for the majority of savers to ensure that they have enough funds for a comfortable retirement.
Step one: Set aside 15% of your income
If you're still at least a couple of decades away from retirement, then saving 15% of your earnings in a tax-advantaged retirement account during your working life should yield a respectable nest egg. Consider the example of a 30-year-old worker taking home a $50,000 salary. If he gets a 3% salary bump on average each year, and his investments earn an average annual return of 7% during his working life, then saving 15% of his income would bag him $1.7 million by the time he reaches age 65. That's enough money for a pretty darn nice retirement while still leaving something for the kids.
On the other hand, someone who starts saving at age 45 would need to save $22,797 per year to hit $1 million by age 65, assuming the same 7% return. That's pretty tough to manage on a $50,000 salary, so if you're shooting for such a lofty retirement goal, you should consider putting off your retirement a few extra years to give the money more time to grow. Just shifting the retirement date forward to age 70 would give the same 45-year-old a savings goal of $14,776 per year instead of $22,797 -- a far more achievable target.
Step two: Put your retirement savings into a tax-deferred retirement account
If you have a 401(k) plan at work, this is really easy to accomplish: Simply ask your HR representative for the 401(k) contribution paperwork and fill it out specifying that you want 15% of your wages to go into the 401(k). Some 401(k) trustees will let you set your contribution percentage right on the brokerage website. You'll also need to decide which investments to funnel your 401(k) savings into -- more on that in a moment.
Because this money will come out of pre-tax income, you'll even save some money on your Social Security and Medicare taxes. Your contributions will also be spared from income tax, though you'll have to pay income tax on your withdrawals from the account.
If you don't have a 401(k) plan, you'll need to open an IRA instead and set up an automatic transfer from your bank account to your IRA. These contributions won't be coming out of pre-tax dollars, but you do get to deduct you contributions on the current year's tax return, so it works out to roughly the same thing at the end.
Step three: Put the money in a target date fund
Nearly every tax-deferred retirement account will give you access to one or more target date funds. These funds will choose your investments for you based on when you plan to retire. The fund name typically reflects the intended retirement date: If you plan to retire sometime around the year 2050, you'll choose a target date fund with 2050 in the title. If your 401(k) or IRA is one of the few that lack access to a target date fund, split the money between a stock index fund or ETF and a bond index fund or ETF.
So how much money should you allocate to stocks, and how much to bonds? Here's a simple guideline that works for investors who want growth but not a whole lot of risk: Subtract your age from 110 and put that percentage in the stock fund, and put the remainder in the bond fund. For example, if you're 30, you'd put 80% in stocks and 20% in bonds.
Step four: Check in once a year
This retirement plan is pretty hands-off once you get it going. However, you'll want to review your account at least once a year to make sure it's doing OK compared to the overall market. Your 401(k) or IRA trustee will provide you with performance reports, including a brief summary that will compare the fund's performance to that of similar funds and (usually) the market as a whole. An underwhelming performance may mean it's time to switch to a different fund. If your money is in stock and bond funds instead of a target date fund, you'll also want to shift the allocation as you get older so that more of your money is in bonds, rather than stocks. You can continue to use that "110 minus your age" formula to figure out how much you should have invested in stocks versus bonds.
Step five: Enjoy your retirement
When you get within a few years of retirement, you may want to sit down with an investment advisor specializing in retirement planning to make sure you're on track with your savings and will have enough income to live the retirement you want. It's best to do this five to 10 years before your planned retirement date so that you have a little time to course-correct if necessary. If you choose not to seek professional advice, however, you'll probably manage just fine on your own. Not bad for a retirement plan that takes just 15 minutes of your time.
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