The amount of money you should invest for retirement doesn’t depend on how much you can invest.
Investors frequently make the same mistake when deciding how much to invest for retirement: They confuse “should” with “can.” How much you should invest is not dependent on how much you can invest.
If saving for retirement is important to you, it should be the first line item on your budget. Figure out how much you need to save to achieve your retirement goals, then live on whatever is left over. Of course, the caveat to that is if your goals leave you with too little to live on today, you may need to change those goals so you can still eat between now and retirement.
This still leaves investors with the challenge of figuring out how much they need to be investing for retirement to reach their goals. Unfortunately, the answer is not intuitive, says Chad Parks, founder and CEO of Ubiquity Retirement + Savings. “You can’t just say $100 a month sounds good. What does that mean to you today and in the future?”
Parks prefers to approach the savings question in terms of how much future income today’s savings will buy you. This removes the intimidation factor often associated with needing to hit some “magic number,” he says. Knowing you need $2 million to retire comfortably when you’re only earning $50,000 per year can sound daunting to the point of impossibility. It sounds much more doable if you can say, to get $2,000 per month in retirement, I need to save $500 per month today.
Many online savings calculators will do this calculation for you. If your employer retirement plan doesn’t offer one, CalcXML’s “How much retirement income may my 401(k) provide?” calculator is a great free option. It shows you how much monthly retirement income you can expect from three investment strategies (conservative, moderate or aggressive) based on your 401(k) contribution amount.
How Much Do You Need to Invest For Retirement?
Basing how much you should invest for retirement on how much income you’ll need in retirement begs another big question: How much will you spend in retirement? While you should eventually do a detailed analysis of your anticipated retirement spending, don’t fret too much about it when you’re just starting out.
“Whatever your take home pay is today after taxes, pick that as your number,” Parks says. So if you’re taking home $3,500 per month today, assume you’ll need that same amount (adjusted for inflation of 2% to 3% per year) in retirement.
If you’re within 10 years of retirement, however, you should fine-tune that number, says Jason Friday, head of wealth management planning for Citizens Bank Wealth Management.
You’ll want to account for things that will change after you retire, he says. This might mean adding or subtracting expenses from your current budget. For instance, you might subtract the cost of commuting to work but add in the cost of traveling to see the grandkids more often.
And don’t forget to factor in longevity. Saving for retirement isn’t just about how much you need each year but also how many years you’ll need to provide for. At Citizens Bank, they start with an average life expectancy of 90 years for men and 92 years for women, then dial it up or down based on family history and your current health status, Friday says.
The other moving piece to account for is your anticipated income from other sources in retirement, such as social security, a pension and your investment return in retirement. This last can be hard to get right; stock market returns are impossible to predict, after all. Friday suggests using a conservative anticipated return of 4% to 5% per year in retirement.
He also advocates running multiple scenarios: What will it look like if your portfolio only earns 3% per year? What if it earns 6%?
While you can do all this fine tuning yourself with an Excel spreadsheet or free software, everyone – particularly near-retirees – can benefit from sitting down with a financial advisor. You only get one shot at retirement, after all; might as well make sure you’re planning for it as thoroughly as you can.
How Much are You Willing to Invest For Retirement?
It’s only after you’ve determined how much you’d need to save today that you should turn a critical eye to your paycheck. This is when you can compare what you should be saving with what you’re willing and able to save.
Remember, the government, and possibly even your employer, is incentivizing you to invest for retirement. When you allocate 10% of your income to a pre-tax account like your employer retirement plan, it’s 10% before taxes. So while $6,000 of your $60,000 salary goes toward retirement, your annual take-home pay may only shrink by $4,500.
Similarly, if your employer matches your contributions up to 4% or your salary, your first 4% contribution from each paycheck is now worth 8%.
No matter how much you need to invest for retirement, always contribute at least enough to get your full employer match. Even if you only need to invest 2% of your salary, if your employer will match 4% put in the full 4%. There’s no sense leaving free money on your employer’s table.
That said, “there needs to be a balance between satisfaction today and what you think will give you a satisfying life in retirement,” Friday says. He sees people over-saving and “mortgaging the present for the future” as much as he sees them undersaving.
Faced with multiple financial goals and limited, competing resources, the question becomes one of priorities. Do you prioritize saving for retirement or a down payment on a house? Paying for your kid’s education today or taking your grandkids to Disney World every year in retirement?
Investing for retirement needn’t be all-or-nothing: You can save for retirement and that three bedroom house at the same time. You just may not be able to save as much as you’d like to either one.
The upside is money isn’t everything. Your relationship with your spouse, health, connection to your community and sense of purpose contribute more to retirement satisfaction than spending, Friday says. So maybe don’t skip that anniversary trip to Italy in favor of a couple thousand more invested for retirement.
Source: U.S. & World Report News
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