Do You Really Need a Million Dollars to Retire?

by Junior Boomer on November 4, 2010

The thought of saving millions of dollars for your retirement is a daunting one, and one which not many of us would be able to achieve all on our own. Luckily there are employer programs which will contribute towards your retirement funds, as well as match your own contributions to the fund, plus you can utilize the equity you’ve worked so hard to build in your home, or through other assets.
Do You Really Need a Million Dollars to Retire?
Creative Commons License photo credit: i_spec
So do you really need to retire as a millionaire to sustain your lifestyle through your golden years? To determine how much you need to save for your retirement you need to start asking yourself some important questions such as:

  • When do you want to retire?
  • Are you financially prepared for all the activities you want to do in your retirement?
  • Are your investments able to withstand long term market movements and inflation rates?

With these questions clarified in your mind you can start working towards just how many millions you need or don’t need in your retirement, and how much you need to be saving now to reach that goal. For example, if you are young and in your 20s or 30s you can be putting away just 15% of your income to provide for your retirement. Most financial experts agree that you should plan to have between 60% and 80% of your pre-retirement income amount to live on each year once you retire, so you now need to work out the size your savings need to be to generate that sort of income for you because Social Security benefits replace on average just 38% of pre-retirement income.

Before you can successfully save for your retirement, you need to have a goal amount, which you can work out in four simple steps:

  • Calculate your savings goal. For example if you are likely to be earning $65,000 before you retire, the plan to need at least 70% of that amount, which is $45,000. Keep in mind this is the current dollar amount you need, during each of your non-working years.
  • Calculate existing retirement income. This includes the amounts you and your partner will receive from Social Security benefits. The average payout amount for a couple would be around $28,000 plus amounts you already have in savings or investments which will continue to grow until you retire. As an average, calculate for an additional $7,500 in other savings and investment income in your retirement.
  • Subtract your estimated income from the amount you have estimated your retirement expenses will be, for example your income of $45,000 less yearly expenses of $35,000. In this instance you have a shortfall of $10,000 a year and so you will need to add to your retirement savings. You can do this by taking on another job, but keep in mind that if you are under 70 years of age, you will pay a lot more in Social Security taxes.
  • Set out an investment strategy. You will need to choose an investment strategy depending on how close you are to retirement age. For example, the closer you are to retirement age, the more conservative you will have to be. But don’t be discouraged because even at 50 years old you still have 15 years to build the millions you need for retirement. The most important thing to remember if to diversify your investment portfolio because there is so much at stake.

Young Millionaire Aspirations

When you’re young there are so many other things to think about than saving for your retirement – you’re worried about getting out there and living, not saving for the years before you die.

However, the earlier you start saving for your retirement, the easier it will be to achieve the asset base you need. At the same time you don’t need to be saving for a specific retirement goal amount just yet, just save as much as you can. This includes employer matching contributions to your 401(k) account so you don’t have to divert 15% of your income directly to your retirement fund, as there are other sources.

For example, if you are a young single worker earning $50,000 a year and you contribute to your 401(k) then your employer will contribute 50 cents for every dollar, up to 6% of your salary. Therefore, you’ll need to contribute just $3,000 a year, which is $250 per month to qualify for the largest matching amount of $1,500 from your employer.

Plus contributions to your 401(k) are made in pre-tax dollars so by making a $250 contribution each month you are reducing your take home pay by just $187.50 or $2,250 each year. You won’t notice the contribution because your employer will be deducting it from your salary and this contribution already has you halfway to your 15% goal.

Mid-life Realizations

Of course the older you get, the less time you have to earn interest, make investments and ride out the turbulence in the market. Therefore, if you are in your 50s you need to pin down the exact amount you need to live the life you want in your retirement and you need to start planning on how you’re going to achieve it.

If you’ve not thought about your retirement then you’re not alone because only 42% of workers have taken the time to determine their retirement savings needs. Therefore, you may have gotten to your 50s before realizing that you should be making additional contributions to your 401(k) but it’s not too late. In your 50s you can make catch up contributions to help you reach your goal, but you don’t need to rely on just your 401(k) or Social Security payments because you may also be planning to sell your home and move into a smaller apartment or a more affordable suburb away from the city, so you can live off of those funds too.

To work out your retirement number and find out how far away you are, consider the formula of calculating how much you will need to draw on during your first year of retirement, and then multiplying that by 25. This formula allows you to withdraw 4% of your retirement savings in the first year, as well as increase that amount each year to allow you to keep up with inflation.

For example, if you retire at 65 and expect you will live another 30 years in retirement, this formula guarantees that you won’t run out of money because you are withdrawing just $40,000 of a $1 million nest egg during the first year of your retirement and the rest of your savings are protected from fluctuations in the market, regardless of the state of the economy at the time.

Of course, now is the time to start thinking about how you want to live your retirement and the things you want to be doing because saving and accumulating assets to the value of 70% or 80% of your pre-retirement income may not always be needed. For example, you could retire to a country town and are likely to spend just 25% of your pre-retirement income in a year because your biggest expense will be gone by the time you retire – your mortgage. In this case you may be able to live off of your social security payments alone, and keep your nest egg for investments in a camper or an overseas holiday.

How to Set Up Savings Plans and Asset Bases

It is exciting to get caught up in retirement fantasies but once you’ve worked out how much you need, you need to know how to put plans in place to get you there in time. The amount you need to save will depend on your goals and your age, but remember that in the early years of your retirement savings plan, don’t rely on investment performance because it is your own contributions which will have the greatest impact.

For example, if you increase the contributions you are making to your retirement savings by 2% rather than relying on growth through investment performance, over 15 years your retirement savings balance will have doubled, when compared to just relying on your investments to do their thing. Of course, as the balance increases over time, the performance of your investments becomes more important because you have more to lose, and more opportunity for gains with the right investment options.

It is also much easier to increase your own contributions to your retirement funds, rather than spend the time researching, choosing and managing investments which will fund your retirement. As a result, there are now a range of DIY 401(k) plans which give you a way to easily increase your contributions. Your employer will automatically enroll you if you are eligible and you can opt out if you have a different strategy, however, you can choose the option to have increases to your salary automatically deferred to your 401(k) or you can choose a life-cycle retirement investment which is a balanced portfolio which becomes more conservative as your retirement age approaches.

Alban is a personal finance writer at Home Loan Finder, which offer information on reverse mortgages

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{ 1 comment… read it below or add one }

Larry Staton December 4, 2010 at 12:22 pm

What do I do now I am 53 I lost my business due to the economy and now I am working by the hour trading time for dollars, my wife was diagnosed with terminal cancer and without insurance we have lost just about everything. We only owe 70k on our home but now I have to try and rebuild a retirement fund so I can retire in fifteen years…. how can I do this safely I cannot absorb any more set backs.

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