Monthly Archives: February 2017

Steps to Save More for Retirement

One of the most common questions a financial advisor hears is, “Am I saving enough for retirement?” This seems to be at the top of people’s minds, especially as they get older. Because every person’s dreams and goals are different, there’s no one-size-fits-all answer. However, there are three things that everyone should be doing to get as close as possible to the goal of having enough money for retirement.

Aim to Save 15% of Income

It’s important to have a specific goal when saving for retirement, so you have something to work towards. Generally speaking, it’s recommended to save 15% of your pre-tax income toward retirement. That is $15,000 for every $100,000 you make a year. (For more, see: 10 Steps to Retire a Millionaire.)

While the earlier and the more you save the better, 15% is a reasonable number for most people to fit into their budget. It works well because it is enough to build a nest egg, but not so much that it will hurt you in the present.

For many people, their only goal is to contribute up to the match on their company’s 401(k) plan. While this is a good goal, it is not enough. You can’t assume that just meeting the match will be enough to build a sufficient nest egg.

Not only is contributing up to the match not usually enough, but sometimes even maxing out your company’s retirement plan isn’t enough. The annual contribution limit on a 401(k) plan is $18,000. If you make over $120,000 a year, a 401(k) alone won’t be enough to get you to 15%. You will need to save elsewhere as well, like in a Roth IRA (if eligible) or even a taxable account.

Don’t assume that since you’re maxing out your company plan that you’re saving enough. While it may be enough for some people, if you’re used to a higher standard of living because of your higher salary, you’ll need more savings. Instead of focusing on specific accounts, focus on saving 15%.

Invest Your Savings Intelligently

Although 15% is an important goal to shoot for, how that money is invested and the vehicles used are of equal importance. You’re working hard to save all that money, so don’t let your efforts go to waste by not handling it wisely.

One of the biggest investment mistakes an investor can make is investing long-term money too conservatively. While your risk tolerance is an important factor in choosing an investment, it’s important to know the trade offs, because all investments are not created equal. And the longer your time horizon, the greater the inequalities grow. (For more, see: Not All Retirement Savings Accounts Should Be Tax-Deferred.)

For example, let’s say you are going to invest $15,000 a year for 30 years. If you put it in a fixed investment earning 2% a year, you will end up with $620,000. That may not sound bad, but let’s take a look at the trade off. If you were to invest that same money in equities earning 7%, you would end up with $1,520,000. That’s a $900,000 difference.

Rates of return will have a great impact on the amount that you are able to accumulate, but so will the kind of investment vehicles you choose to use. Your savings will probably be much more effective if put them in a Roth account instead of a regular account.

If you choose to use a Roth 401(k) instead of a regular one, there will be a difference in your take-home pay. Roth investments are post tax, while regular 401(k)’s are pre-tax, so you will take home less with a Roth. However, when it comes time to withdraw your money, there will be a difference as well.

Remember our example above, with $15,000 invested annually over 30 years into an equity investment earning 7%? Had that money been invested in a Roth 401(k), the $1.5 million would be tax-free upon withdrawal. If it were in a regular 401(k), the $1.5 million would be taxable as you withdrew your money. That’s a huge tax savings just for using a different kind of retirement account.

Do the Math

If you’re wondering if you’re saving enough for retirement, the better question to ask is have you ever calculated just how much money you will need in retirement? Have you ever taken the time to sit down, look at the numbers, and do the math to come up with a target nest egg?

You should. Simply knowing how much money you need can be a strong motivator to increase your savings habits. This can be huge if you have a long time to save for retirement. Calculating the numbers to see how much accumulated interest will contribute towards your nest egg instead of having to save it out of your income later in life can be mind boggling. Continuing the above example, if you waited 10 years to begin saving, you would have to set aside over twice as much per year to end up with the same amount of money!

If you’re doing all that you can to save, but still don’t feel that you’re saving enough, it’s time for a second look at your budget. Often, after a thorough analysis, you can find more money to put away for retirement. It can be as simple as defining needs versus wants in light of your bigger goals.

Sometimes, the thought of calculating retirement needs and deciding on investments can be overwhelming. Know that there is help. Financial professionals can help provide guidance with your personal situation.

Saving Money Is Important

If you don’t earn much and you can barely pay your bills, the idea of saving money might seem laughable. When you only have $5 left at the end of the month, why even bother to try saving? Because everyone has to start somewhere, and if you work at it, your financial situation is likely to improve over time. Saving money is worth the effort. It gives you peace of mind, it gives you options, and the more you save, the easier it becomes to accumulate additional savings.

Peace of Mind

Who hasn’t lain awake at 3:00 a.m. wondering how they were going to afford something they needed? If money is really tight, you might be wondering how you’re going to pay the rent next week. If you’re a little further up the financial ladder, you might worried about how many months you could pay the bills for if you lost your job. Later in life, the money thoughts that keep you up at night might center around paying for your kids to go to college or having enough money to retire. (Get help with college savings by reading Stop Procrastinating! Enroll In A College Savings Plan.)

As you accumulate savings, your financial worries should diminish, as long as you’re living within your means and not always looking for new things to worry about. If you already have next month’s rent taken care of by the first week of the current month, if you know you can get by without work for three to six months, if you have savings accounts for your children’s education and your own retirement that you’re regularly funding, you’ll sleep better at night. The reduced stress from having money in the bank frees up your energy for more enjoyable thoughts and activities.

Expanded Options

The more money you have saved, the more you control your own destiny. If your job has you on the verge of a nervous breakdown, you can quit even if you don’t have a new job lined up yet and take time off to restore your sanity before you look for new employment. If you’re tired of living in an unsafe neighborhood, you can move to a safer area because you’ll have enough for a deposit on a better apartment or a down payment on a nicer home. (Is buying a home in your future plans? Read How To Buy Your First Home: A Step-By-Step Tutorial.)

If you get sick and need expensive healthcare that your insurance doesn’t cover, you’ll have a way to pay for it even though you can’t work while you’re getting treatment. And knowing that you have options because of the money you’ve socked away can give you even more peace of mind.

No, money doesn’t solve every problem. It you are laid off, it might take as long as two years to find a new job. Some illnesses won’t go away no matter how many procedures you can afford, and random crime can happen even in a supposedly secure gated community. But with more money in the bank to deal with issues like these, you give yourself better odds of coming out on top.

Money Working for You

Most of us put in hundreds of hours of work each year to earn most of our money. But when you have savings and stash your funds in the right places, your money starts to work for you. Over time, you’ll need to work less and less as your money works more and more, and eventually, you might be able to stop working altogether.

What does it mean to have your money working for you? When you’re first starting to save, you’ll want to put your money somewhere safe, where you can access it right away for unforeseen expenses. That means an online savings account, where you might earn 1% interest annually and not even keep up with inflation, which tends to run around 2% to 3% per year. You’ll even have to pay taxes on your meager 1% earnings. Anything is better than earning 0%, though, or not having savings and going into credit card debt, which will cost you 10% to 30% in interest per year. (For related reading, see Why You Absolutely Need An Emergency Fund and How To Use Your Roth IRA As An Emergency Fund.)

Once you’ve saved three to six months’ worth of expenses in your emergency fund, you can start saving money in a tax-advantaged retirement account. That’s where the magic starts to happen. These accounts, such as a Roth IRA or 401(k), allow you to invest in the stock market. If you do it right, you’ll earn about 8% per year on average over the long run. You won’t pay any taxes on those investment gains along the way, which will help your money grow even faster. With a Roth IRA, you contribute after-tax dollars, and everything that’s in the account after that is yours to keep. With a 401(k), you get to contribute before-tax dollars, giving you more money to invest up front; you’ll pay taxes when you withdraw the money in retirement. (If you’re not sure whether it’s better to pay taxes now or later, you can hedge your bets and contribute to both your employer-sponsored retirement plan and a Roth IRA.) The third choice, a traditional IRA, allows you to contribute before-tax dollars as you do with a 401(k).

If you have a high income and low expenses, you might accumulate enough to retire in 10 years. For most people, it takes closer to 40 years. But at some point, if you save and invest regularly, you should be able to live off the income generated by your investments – the saved money that’s working for you. The earlier you start, the more time a small amount of money has to grow large through the miracle of compounding.

Retirement Income or Savings

Although many Americans worry about retirement and are doing everything they can to save for it, they commonly look at their retirement plan balances as means of measuring their progress. But the ultimate end of retirement savings is to generate income, so projecting your future cash flow can provide a more realistic indicator of financial preparedness. The key is to remember that there is a statistically a real chance that you could live well into your nineties.

Analyzing Desired Cash Flow

The first step to projecting your cash flow during retirement is to look at your current budget. If you are able to save at least 10% of your income now, then your retirement income will probably only need to be 90% of your current income level at most, with adjustments for inflation. But the amount of income that you will need after you stop working is not likely to be substantially less than what you need now. If you make $75,000 now and plan to retire in 10 years when you are 70 years old, then you will probably need to receive at least $65,000 a year after you retire unless your expenses are going to be a lot lower than they are now. If you plan on staying in your current residence and will have it paid off by retirement, then you can obviously reduce your monthly expenditures by the amount of principal and interest (but not insurance and taxes) that you are currently paying each month. (For more, see: Will Your Retirement Income Be Enough?)

Translating your nest egg into monthly income requires the quantification of several variables and the ability to perform some time-value of money (TVM) calculations. There are several TVM calculators available online at websites such as Bankrate.com, and these tools can help you to see how long you can realistically make your money last with a given set of assumptions. If you have $250,000 saved up and need to make your money last for 30 years, then you will need to allocate a significant percentage of your portfolio to equities. However, you may want to take a more conservative overall position in your portfolio during the first few years of retirement, because your draw down risk (the chance that you will significantly decrease the earning power of your portfolio from initial market losses) is the greatest during your early retirement years.

For example, if you have $500,000 in your 401(k) plan and your plan balance drops by $150,000 the year after you retire because of a market correction, then you have lost $150,000 of principal that you could have used to generate investment income for the rest of your life. Therefore, a more stable allocation at the beginning can help you to avoid large initial losses that can permanently cripple your portfolio. But if the numbers that you run show that you’re not going to have remotely the amount of income that you want to have when you retire, then you will need to start considering some major changes such as delaying your retirement or downscaling your future lifestyle. (For more, see: Protect Retirement Money from Market Volatility.)

Delaying your Social Security benefits can also increase your income in your later years if you are able to afford this option, but you may be better off taking it earlier and then socking that money away in a Roth IRA or other retirement vehicle while you continue to work. There is no one right answer to solving the retirement income equation, but some options are almost always going to be better than others. You may want to take a look at a longevity insurance policy that will provide a substantial guaranteed monthly payout after age 85 if you think that there is a good chance that you will make it into your nineties. This type of policy can allow you to map out the rest of your retirement plan with more precision, as you will usually only have to make the rest of your savings last until this payout kicks in.

Get Professional Help

Cash flow analysis is where a financial planner can really be of service. A comprehensive financial plan can show how long your money will last at a given rate of dispersion in your tax bracket. It can also incorporate other variables such as market performance and your estimated Social Security benefits. Perhaps most importantly, it can also show you what will happen with your finances if you live to be 95. About one in five Americans will. And a financial planner who also manages assets can help you to determine the correct mix of assets during each stage of your retirement so that you can get the most from your money over time.