Many people focus on how much money they need to accumulate so they can stop working. The question then becomes, “How do I get there?”
Most of us contribute to a 401(k) at work, but often just enough to capture any employer matching funds. Let me tell it to you straight. If you are contributing only 4% to your 401(k), or even 6%, that alone is not going to get you where you want to go. And self-employed people may not be aware that contributing the maximum to a SEP IRA may not be enough, either.
HOW MUCH TO SAVE
After running hundreds of financial plans for all kinds of families, I’ve developed the following rule of thumb. (Like any rule of thumb, take it with a grain of salt.)
If you have not been setting aside 10% of your gross paycheck every year since you first started to work, here is how much I recommend you should start saving now, depending on your age.
Your age range Annual savings rate (minimum)
The good news is, if you started saving 10% of your pay when you were in your 20s, you’re on a good track.
For the rest of us, the math is simple. If you are in your 40s, for example, you might work another 20 years, but you might live another 50 or 60 years. (Don’t scoff! Lots of us are going to live to 100.) The money you save from ages 40 to 60 has to provide the money you’ll spend from ages 60 to 100. That’s why I recommend saving 20% or more.
And that assumes Social Security will be a noticeable help to you. For high earners, the maximum benefits won’t cover even half of their retirement spending. And for everyone, Social Security benefits may be reduced, or further taxed, or means-tested.
You can’t assume a high rate of return on your investments will make up the gap. Far more important than the rate of return is the amount of money earning that return. You’ve got to save enough, and not just invest aggressively.
If you want to drive to Cleveland, I can recommend a car for you, and tell you to buy gas, but you’ve got to actually buy the gas. In the same way, if you want to retire comfortably, I can recommend a portfolio, and tell you how much to save each year. But you’ve got to actually save the money.
Here’s the question I hear all the time: “How can I possibly afford to save 10% or 20% of my income?”
FINDING MONEY TO SAVE
Roughly speaking, after you pay your income taxes, there are four ways to direct your cash flow:
1) Past spending, e.g., paying off loans you took out to buy an education, car or home
2) Present spending, e.g., rent, utilities, groceries and fun
3) Future hardships, e.g., insurance against risks to your property, health and income
4) Future good times, e.g., buying a home and retiring!
Past spending is best addressed by restructuring debt to lower the interest rates, and to make the payments acceptable in size. Usually, there is only so much we can do here. First step: pay off your credit cards, in full, every month!
Present spending can easily consume most of your paycheck, given the costs of living in Orange County. Millennials start out mainly working to stay ahead of student loans, a car, rent or mortgage, and basic costs of living. Gen Xers and Boomers are paying for kids, bigger houses, maybe two households after a divorce, and perhaps some of their parents’ costs. Very often, their income plateaued in their mid-40s, and their career hit some bumps and interruptions in their mid-50s. I get it. Meeting today’s bills and paying off debt is not easy.
That makes it especially hard to spend enough on the future. Everybody who is working should have some disability insurance for their own benefit, and life insurance if they are supporting loved ones. Health insurance is frustratingly expensive, but catastrophic to go without. You should consider life insurance on a “non-working” spouse, especially if you have young children, because without him or her in the picture, the surviving family will probably have higher expenses for daycare and other important needs.
After all that, who has any money left to save for retirement? Let me give you something important to consider.
A DOUBLE BENEFIT
Every dollar you choose to save for retirement means spending less today. If two of the categories above are relatively fixed (i.e., payments on past loans and payments you’re making for insurance), the other two are directly in your control: what you choose to spend now and what you choose to save now. It’s not easy to be diligent about saving. But saving has a double benefit!
If you develop the habit of ongoing savings, you are also implicitly developing the habit of spending less! If you shave a little off your lifestyle right now, and maintain that savings throughout retirement, you’ll be spending a bit less “forever” (or at least the next 50 or 60 years). That means you won’t need as big a “pile” of money to fund your retirement spending.
Saving more means spending less, and spending less means you need to accumulate less for the future. It’s a virtuous cycle! It is as if you are climbing a mountain, and with every step you take, you get two steps closer to the top.
MAKING IT WORK FOR YOU
Still, saving money is not easy. It took some big adjustments for me to get on track with my own retirement savings —and later than I’d like to admit! I chose to make moderate changes while still working, rather than larger changes later. I changed my housing as the kids were finishing high school, which eliminated the pool man, homeowner’s association, and Mello Roos assessments, among other expenses. I enjoyed a luxury convertible for a few years, and now have switched to something that costs a lot less to gas up, insure, and repair —now that’s a luxury! Unlike some families I know that faced these issues too late, I won’t have to make drastic changes, or even move away from Orange County, to afford basic needs in retirement.
You might not need to make dramatic changes around housing and cars. Creative planning around other big-ticket items, like second homes, vacations, and kids’ education, can make a similar impact. And there are dozens of creative ways to save smaller amounts — whatever works for you.
The point is, you may feel stuck. But you really can balance past, present and future spending. And it will feel really good!
FEELING FREE, EVEN BEFORE YOU RETIRE
These are two major emotional benefits of making changes so you can save enough to retire:
Flexibility. Life throws curve balls. Saving more now means you’ll have the flexibility to deal with major medical expenses, disability, career disappointments, or other “unforeseeable” but surprisingly common events. Flexibility means you can deal with future hardships.
Peace of mind. The later you correctly balance your spending and saving, the harder it will be. If you can make changes now (and ideally well before your 50s) to get on a sustainable path, I urge you to do so. I felt a little ego bruising when I right-sized in my 50s, but the confidence and freedom that came from knowing where I stand —and that I am on solid ground financially —more than made up for it. Peace of mind means you are on track for future good times.
LET US HELP YOU
At WorthPointe, we don’t focus on the “pile of cash” you’ll need to retire. It’s more accurate to think in terms of total future spending needs, and all the available resources to cover that spending. These could include Social Security, pensions, part-time work, and yes, that pile of retirement savings. The WorthPointe Freedom Score estimates the probability that all your resources will cover your future spending, without having to adjust that spending (either as a result of not having saved enough, or because investments go up and down over time).
We can assess your WorthPointe Freedom Score, and help you take productive steps right now to make your financial picture stronger!
Give us a call today to get rid of that gnawing uncertainty, and to get your overall situation on solid footing. We look forward to talking with you!
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