If only saving for retirement was simple. Yes, many Americans defer into their 401(k) or 403(b) to make sure they get their employer’s matching contribution, but is the 4% match and salary deferral enough? Here are 5 things you should consider when deciding how much to save for retirement.
1. Saving as much as you can, as soon as you can
When you finish your undergraduate or graduate degree, you finally have a regular paycheck. Life is good as you can finally start paying off debts, replacing that old car, and taking that longed for trip abroad. After those expenses, there’s not a lot left to put aside for retirement. And who cares? Retirement is 40 years away. That’s something that your parents are worrying about and we know how old they are!
But aggressively saving for retirement in your early years can have significant benefits not just on your retirement but even in midlife. Consider two individuals, Grace and Andrew. Both are 25 today. Grace wants to start saving for retirement today but Andrew decides to wait until he is 35. They each want to have $1 million saved by the time they retire at age 65.1
Grace, 25, starts saving today
Required saving amount per biweekly paycheck to achieve goal = $131/paycheck
Andrew, 25, starts saving ten years later
Required saving amount per biweekly paycheck to achieve goal = $308/paycheck
While there can be valid reasons for not starting retirement savings today, the financial impact of waiting is significant. Waiting just 10 years requires more than doubling the per paycheck savings rate in order to achieve the goal.
2. Don’t forget about taxes
The most common way investors save for retirement is through their employer provided retirement plan such as a 401(k) or 403(b). The traditional salary deferral contribution goes in pre-tax which means that when you retire, 100% of your withdrawals will be taxable. With diligent saving and some market appreciation, over time these balances can get pretty big. In the above example, the goal was $1 million. If that balance went into the retirement on a pre-tax basis, you really don’t have a million dollars. It’s more likely somewhere between $500,000 and $750,000 after paying income taxes on the withdrawals. So, don’t get too excited if you already have a million dollar 401(k) or IRA. Consider making after-tax Roth contributions to your retirement plan.
3. And health care expenses
During our working years, most of us are usually in good health and therefore not thinking about how our health care and medical expenses might change when we are in retirement. But the reality is that as we get older, most of us are going to need more of these services. Even if your health is good, don’t forget about prescription drugs. Some drugs are expensive or may not be fully covered by your medical plan in retirement. Consider opting into a high deductible health plan and setting up a health savings account.
Of course, a bigger concern is if you need skilled nursing care at some point and most of us will. While you may be thinking about going out like Thelma & Louise in the 1991 movie, the more likely scenario is that you will spend at least some time in a skilled nursing facility before you pass into the great beyond.2 And it’s not cheap. In the Boston area, the average cost of care is $433 per day or 157,863 per year. Multiply that by 4 years and you’re talking about over $600,000. Not everyone needs to buy long term care insurance, but planning for the potential expense should be part of your retirement planning.
4. Inflation, the leaky faucet
Do you remember your parents or grandparents reminiscing about what a loaf of bread used to cost or what they paid for their first house? Seems irrelevant today but 20, 30 or 40 years from now, you may be telling the same stories. The bottom line is that prices go up over time and that means the value of your savings are continually being eroded unless they are growing faster. So, you’ll need to save enough to have enough to pay for things in the future. In the example above I used $1 million as a target nest egg. But if you need $1 million in today’s dollars and are going to retire in 20 years, $1 million won’t be enough. If we use an average inflation rate of 3%, you’ll need $1.8 million in order to buy the same amount of everything you are buying today for $1 million. Consider selecting investments that have the potential to keep up with inflation.
5. Spending will change
Over your lifetime, the types of things you buy will change. When you are a new homeowner, you tend to have a lot more expenses for furniture and decorating. When you become an empty nester, your mortgage may be paid off and you may have made your last college tuition payment. And then during your Golden Years, you may have significant health care or medical expenses. As you think about your financial life and its different stages, it is important to consider how your expenses will change over time. As a financial planner, one thing I’ve seen over time is that most people tend to spend 100% of every paycheck each month. That doesn’t mean they are not saving, it just means that they allocate 100% of all of their income. So, make sure you are always saving part of every paycheck, both in your retirement plans and outside of them, too.
All of this may sound daunting, but it doesn’t have to be. Take each step one at a time. Chunk it out and then pat yourself on the back for every little financial win. It takes time but it can be done.
If you are looking for advice on how to best plan for retirement, give me a call. We’re here to help. You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
· Investing as an empty nester: What’s different? https://planwithfps.com/blog/investing-as-an-empty-nester-whats-different
· How to prepare to retire “solo” https://planwithfps.com/blog/how-to-prepare-to-retire-solo
· 4 must-do’s before your retire https://planwithfps.com/blog/4-must-dos-before-you-retire
1 Assumptions: $1 million ending balance at end of period; time period for Grace = 40 years; time period for Andrew = 30 years; hypothetical rate of return = 8%; contributions are based on a bi-weekly pay cycle. Examples are hypothetical and do not consider the effects of inflation or taxes. As they say, “your mileage will vary depending on your own circumstances.”
2 The average stay in a skilled nursing facility is 2.6 years. Of course, some will have a shorter stay and others will stay for significantly longer than the average.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.