Saving for your retirement will likely be the largest financial priority of your life. While it will take decades to go from having no savings to having sufficient funds socked away to cover your costs in your golden years, the process of saving for your retirement can be quite straightforward. This 12-step checklist can get you well on your way toward building enough of a nest egg to enable a comfortable retirement.
1. Write down your current age
The most important asset you have when you're saving for retirement is your time. The longer you have to save for your retirement, the less you have to sock away, and the easier it is to get there comfortably. Your age today is key to understanding how much time you will be able to put toward your plan.
2. Write down the age you expect to be when you retire
When planning for your retirement, understand that there's more involved than just you picking a date. Be sure to consider the ages at which your coworkers tend to stop working, your employer's policies for encouraging retirement, any mandatory retirement age, your health conditions, and the physical and mental stresses that work takes on you. You may want to work until you drop, but unless you take steps to get yourself a job that you can keep forever, retirement may find you sooner than you'd like.
3. Figure out how long you have to save
Subtract your current age from the age you expect to be when you retire. That lets you know how long you have left to get your plan, and your full nest egg, in place.
4. Estimate how long your retirement will last
The key number involved that you haven't already estimated is the age you expect to pass away. It's something you can't know to a certainty, but between your own health conditions, your family history, and a life expectancy table, you can probably come up with a reasonable estimate. To be more conservative in your planning, add a few years to what you estimate after looking at those known factors. It's better to leave money behind for your heirs than to wind up broke with years of life ahead of you, and no way to earn the money you need.
5. Calculate your annual budget in retirement
Most people find that their expenses drop in retirement. They've paid off their homes, their kids are grown and supporting themselves, and they no longer having to cover the costs and taxes associated with working. On the other side of the equation, higher healthcare costs and the expenses of paying for help with everyday tasks you used to be able to handle on your own can offset those savings, particularly later in your retirement. Many experts suggest using a number between 60% and 80% of your pre-retirement income as a starting point to calculate what you'll spend, but you should adjust that based on your own circumstances.
6. Estimate your retirement income from other sources
Social Security pays about 40% of a typical retiree's pre-retirement salary and the program provides annual increases based on inflation. Your actual benefits will be based on your salary history, and also the program's degree of solvency around the time of your retire. Beyond that, if you are due a pension or retiree health benefits, or plan to work part time after you retire, that income represents money your investments won't have to cover.
7. Figure out how much your nest egg needs to cover
Subtract your income from other sources (step 6) from your annual estimated spending in retirement (step 5). The amount left over is the money you'll need to cover from your nest egg in your first year in retirement. For example: Say you expect to your expenses will be $40,000 a year, and anticipate $15,000 a year in Social Security income. That leaves you having to cover $25,000 per year out of your own pocket, with that entire $25,000 exposed to inflation risk while the $15,000 from Social Security covered for inflation.
8. Calculate the size of the nest egg you'll need
In step seven, you figured out how much money you'll need to extract from your nest egg each year, and in step four, you estimated how long you'll need that nest egg to last. There's a famous study in retirement planning circles that calculated what percentage of a portfolio a retiree could safely draw down annually, indexing withdrawals for inflation, and remain fairly safe from the risk of outliving their money.
The most famous conclusion from that study became known as "The 4% Rule." The study found that if you expect a 30-year retirement and diversify your portfolio, your safe withdrawal rate is 4% annually. If you're only anticipating a 15-year retirement, you could get away with a withdrawal rate closer to 8%. The shorter you expect your retirement to be, the higher a withdrawal rate you can allow yourself.
To calculate the size of the nest egg you'll need, divide your first year's anticipated spending that the portfolio has to cover by your expected withdrawal rate. So if you'll need your portfolio to cover $25,000 in its first year and you're anticipating a 4% withdrawal rate, you'd need $25,000/0.04, or $625,000.
9. Determine how much you have to save to hit your goal
In step three, you figured out how long you have before you expect to retire. In step eight, you figured out how big your nest egg will need to be at retirement. Using that information, you can figure out how much you need to save along the way to get there. The table below shows how much you need to save each month for each $100,000 of your goal, depending on how long you have to save and what rate of return you expect to earn along the way:
|
Years to Go |
10% Annual Returns |
8% Annual Returns |
6% Annual Returns |
4% Annual Returns |
|
45 |
$9.54 |
$18.96 |
$36.29 |
$66.25 |
|
40 |
$15.82 |
$28.65 |
$50.22 |
$84.61 |
|
35 |
$26.34 |
$43.60 |
$70.19 |
$109.45 |
|
30 |
$44.24 |
$67.10 |
$99.56 |
$144.09 |
|
25 |
$75.37 |
$105.15 |
$144.31 |
$194.51 |
|
20 |
$131.69 |
$169.78 |
$216.44 |
$272.65 |
|
15 |
$241.28 |
$288.99 |
$343.86 |
$406.36 |
Table calculations by the author.
So assume you've got 25 years to save, need to reach $625,000 by retirement, and expect to average 8% returns on your portfolio per year. You'd look up the 8% column by the 25 year row and find $105.15. Multiply that $105.15 by 6.25 (the number of $100,000 blocks you're trying to reach) to get to $657.19, which is the amount you need to save each month to reach your goal.
10. Leverage Uncle Sam and your boss for help
Once you've determined how much you'll need to sock away to reach your goal, see if you have a 401(k) or similar employer-sponsored retirement plan available to you. Money you invest in such plans comes straight out of your paycheck, enjoys tax-deferred growth, and comes with either a tax deduction when you contribute or the potential for tax-free withdrawals in retirement, and may come with a match from your employer, as well.
Those tax deductions and employer matches can reduce the amount you have to contribute out of pocket to reach your goal. If you're under age 50, you can potentially put as much as $18,000 per year into your 401(k) or similar plan; if you're older than that, the annual limit increases to $24,000.
Whether or not you have a 401(k) or similar plan at work, you are likely eligible to contribute to an Individual Retirement Account, or IRA. Similar to a 401(k), money in an IRA compounds tax-deferred, and depending on which type you choose -- the Traditional or the Roth -- you either get a tax deduction when you contribute to the fund, or tax-free withdrawals from it in retirement.
The limits aren't as high for IRAs as for 401(k)s. If you're younger than age 50, the contribution limit is $5,500 per year into your IRA; at 50, that limit jumps to $6,500.
If you need to invest more than you're eligible to put into your 401(k) and/or IRA, you can always stash more money in a traditional brokerage account, and simply earmark it for retirement.
11. Invest with your time frame in mind
Generally speaking, you'll want to build your retirement plan by investing in stocks or stock-oriented mutual funds. When you get within about seven years of retirement, though, you'll want to start building a bond ladder to better assure the money you'll need in shorter time frames will be there when you need it. That way, you balance the need to preserve your spending power for the near term with the need to keep growing your wealth for the long term.
12. Keep at it, and review your progress over time
Once you've started down your retirement savings path, you'll want to review your progress regularly to assure you're staying on track. If you find your results coming in below expectations, the sooner you adjust, the smaller the adjustment will need to be, and the better your chances will be of getting your plans back on track. On the flip side, if you find your results coming in above expectations, you can either reduce the level of your contributions, or set yourself up to quit working that much sooner.
Get started now
By following these 12 simple steps, you can get yourself on track to the retirement you're looking forward to achieving. Time is the most important asset you have on your journey to financial security, so the sooner you get started, the better your chances are of getting there successfully. Get started now, and once you do retire, you'll be very glad you did.
