1/21/2014 5:30 PM ET|
7 retirement planning rules of thumb
These guidelines can help you prepare for a comfortable retirement.
Rules of thumb often develop because they’re at least somewhat accurate and are helpful when running off-the-cuff measurements. When it comes to retirement planning, rules of thumb abound, and they’re often quite helpful in setting savings, investment and withdrawal goals. The following seven rules of thumb for retirement planning will help put you on the right track for a comfortable retirement.
1. Have an emergency fund equal to six months’ worth of income
This isn’t strictly a retirement planning goal, but having an emergency fund is the basis for many good financial plans. If you have money on hand to weather small and large emergencies, you’ll be less likely to stop saving in an emergency, borrow from a retirement plan or rack up high-interest debt because of unexpected expenses. And even if you do have an emergency fund, you don’t have to stick it into an account that earns next to no interest. There are plenty of great places to put an emergency fund, like a high-interest savings account or CD ladder.
2. Save at least 10 percent of your income for retirement
Many financial gurus advocate for paying yourself first by automatically saving 10 percent of your income for retirement. The personal savings rate for Americans is currently 3.2 percent of disposable income, according to 2013 statistics from the U.S. Department of Commerce. Saving 10 percent of your income in a 401k or IRA account every year will get you well on your way to retirement as long as you start early.
However, this rule of thumb breaks down a bit if you don’t start saving until well into your career, in your thirties, forties or even fifties. Starting early allows you to tap the power of compounding interest. The sooner you save, the less you’ll have to put in to meet your retirement savings goals.
3. The percentage of bonds in your portfolio should equal your age
As you age, most experts agree that you should shift more of your portfolio into less volatile investments, like bonds, which will be less likely to lose lots of money if the market crashes. If you’re very young, you can handle more uncertainty and potentially get better returns by investing in stocks.
This rule of thumb is quite conservative. While you might want to have 60 percent of your portfolio in bonds at age 60, having a full 30 percent in bonds at age 30 might be too much for you. It really all depends on your risk tolerance, which has to do with more than just your calendar age. Things like your current job, personality and family situation all play into your risk tolerance, too.
4. You can expect to get an average of 7 to 8 percent per year from a diversified domestic stock portfolio.
When you’re setting goals for retirement savings, many online calculators will ask what you expect to make on your portfolio. Plenty of experts say that you can expect to earn an average of 7 to 8 percent per year from a diversified domestic stock portfolio.
Of course, this is the stock market we’re talking about, so nothing is guaranteed. Depending on where your investments lie, how diversified they are and what the economy is like, you could make more or less than this in any given year. Plan accordingly.
5. Shoot to replace 70 to 80 percent of your pre-retirement income during retirement
Many financial advisers will say that you should aim to replace 70 to 80 percent of your pre-retirement income with Social Security, retirement savings or any other retirement income you may have available to you. Again, this works out for many people, but not for everyone.
For some reason, you may have higher-than-average retirement needs. Maybe you or a spouse has serious medical issues, or you have a disabled dependent who will never be able to live on his or her own. In this case, you’ll want to try to replace even more of your pre-retirement income during your retirement years. However, at least one study suggests that many retirees will need just 35 percent of their pre-retirement income.
6. Plan to save around eight times your final income for retirement
Investment firm Fidelity offers one interesting retirement planning model that can help you set goals by age. The plan winds up with you saving eight times your income by the time you retire. So if you retire at 65, you’ll need to have saved eight times the amount you’re making per year as of that year. This plan is helpful because it gives you goals to meet throughout your working years, including saving one times your income by 35, three times by 45 and five times by 55.
7. Assume you’ll withdraw 4 percent of retirement savings each year during retirement
Many retirement plans are based on the idea that retirees will withdraw 4 percent of their savings per year during retirement. The theory is that you’ll earn 7 to 8 percent, spend 4 percent and invest the remainder to keep pace with inflation. But in today’s low-yield environment, 4 percent may be too much. One New York Times article recently noted that a retiree with a $1 million nest egg invested in municipal bonds (once a favorite of retirees) would have a 72 percent possibility of running out of money before death if they withdrew on those bonds at the rate of 4 percent a year.
Measure twice, cut once
As with all rules of thumb, these for retirement and savings are based on averages. And, of course, no single person is truly average. It’s better to develop a personalized plan when it comes to retirement than it is to operate solely off of rules of thumb. Instead, meet with a financial planner or do more extensive research to set retirement savings and spending goals based on your unique personality, life and financial situation.
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To me, eliminating all debt (mortgages, children student loans, car payments, credit card, medical, etc) debt is critical. Unless absolutely necessary, never enter retirement will a large debt. Downsizing your home too is a big winner as well as moving to a lower tax area if possible.
I also found most people accumulate debt via medical conditions. Obesity derived medical conditions suck the financial health out of families. Lose weight, exercise, and eat right to lower your medical bills. Medical bills are the one measure most likely to ruin a person who strategically worked hard to retire well.
Save like you'll need 80% and hope you'll only need 35% of your salary to be comfortable....that should be cushion enough. You may find out that you will be forced to retire early or you just can.
If you have everything paid off, especially your home, inflation won't have the same impact on you as those that rent.
An emergency fund can come from multiple places when you've saved for your retirement. A Roth can be part of your emergency fund, since you won't need to pay taxes on it, if you suddenly need a lump sum for something.
I'm not a fan of annuities and haven't seen any that are worth the investment. You can't access your funds without a large penalty, once you've annuitized them, and the return right now is especially poor.
The emergency fund needs to be 2 years of expenses when you retire. A 30 day amount is good when you are young. You will want to build it up to a 6 month amount by the time you hit age 50. At retirement you need 2 years of expenses to allow you to ride out any market downturns.
When it comes to saving for retirement, yes it is best to start young. Lets be honest, how many of us had the funds necessary to save when we were young. For those who do it or have done it, great job. For the rest of us, no matter what your current age save as much as you can. Saving any amount is better than saving nothing at all. You will never regret having saved and as your savings grows you will be inspired to save more. Life is short, do not beat yourself up for failures of the past. Look to the future and be proud of what you have done.
Lots of talk about interest rates and rates of return here.
Interest rates are at historical lows. Do you think they will stay there? I don't. Once they start ramping upwards, that 7-8% figure might look pretty low. I remember back in the late 70's and early 80's when interest were hovering around 20% and a bank CD was paying 15%+. It was a great time for conservative investing, not so much if you were trying to buy a house.
Get your stuff paid off. Everything from credit cards to homes. If you can manage that, and have a few bucks stashed for retirement, you will be reaping big rewards in your golden age. I can easily see a CD paying 10%+ again in the not so distant future.
If I am wrong, and interest rates remain low, then you will still have your stuff paid off and still have your money. That is a win win either way.
It is always better to start early, but never too late to start.
Check you spending and cut what and where you can. Do need every app in the world on you cell phone? Do you even need a cell phone? I over hear the conversations and trust me, you don't need to call your friend and tell him about your softball game while your in line at the grocery store.
Do you need a flat screen in every room of your house? How about the cable premium package that you only watch a couple of shows, yet pay for every month?
I am not suggesting that you live like miser or a hermit, but with just a small effort, you can find lots of things to painlessly cut, and start saving more.
What a load of BS this advice is . . . 8 times annual income? 70 or 80% of your income for retirement? BS!
When you retire, you have your home paid off (or nearly so), your kids are gone - thru college or whatever, you've travelled everywhere you want to, you don't have any major debts, you don't care about more new cars, etc., etc. In short, you are an adult!
YOU decide what you want to spend any money one, and it's NOT WHAT YOU USED TO SPEND IT ON!
You can live comfortably on 40% or less of your peak income . . what are you going to spend it on?
You don't go out to expensive restaurants twice a week or daily, you don't buy expensive fashionable clothes or fancy new cars, etc., etc. . . .you've done all that and who needs to keep doing it? You appreciate what's important, and it's NOT BUYING MORE THINGS! Most of the retired people (most of my friends) I know are trying to get rid of things, not buy more!
Gone is the stress and preoccupation with things: Health, for example, is far more important: walk a mile a day and see how much better you feel.
Who profits from this BS advise? - Financial Advisors, that's who, who make a fortune giving you useless financial advise, even though they've not ever been retired.
How do I know this? I studied all the Financial Planners BS at UCLA and have been retired for some years now, and I tell you this without hesitation: It's BS - you don't need anywhere close to what they tell you; they are just trying to get you to invest more with whatever they're selling: insurance, stocks, bonds, other investments.
A weak written article. Before one does any of these "rules of thumb", one should determine what lifestyle they want to have during their retirement years. Do they desire:
1. Not work and just exist - No planning is needed for this. Social security and welfare is enough.
2. Have a lesser lifestyle in retirement - Some planning is required. Maybe "rule of thumb" number one and a portion of number two.
3. Have a degree of enjoyment in retirement - This one gets to be a stretch for most people. It requires a substantial amount of planning and some sacrifice. The "rule of thumb" article starts to be somewhat useless at this point. There are some good suggestions on what SOME people can do, but everyone's situation and degree of risk/reward is different. They will have to balance whether the amount of investments in bonds will generate enough income, or whether their risk tolerance will allow them to invest more into stocks. For this level of retirement "Rule of thumb" numbers three and four will need to be adjusted accordingly.
4. Travel and live comfortably - "Rule of thumb" number five, six and seven only have a grain of wisdom in them but everyone's situation is different. Is that 70%-80% of net or gross income? I believe the writer of the article meant it to be gross income. However, everyone's deductions vary greatly; the federal tax bracket, which state we live in affects the amount of state tax is taken out, what percent is taken for 401-k contribution, etc. I believe we should look at out NET INCOME BEFORE RETIREMENT and determine how much NET INCOME WE WILL NEED IN RETIREMENT. Personally, I believe this is a much better indicator of our retirement lifestyle and will help us make a better decision on when/whether we can afford to retire. What will we be able to afford in retirement on 70%, 100% or even 150% of our current net income? Personal note: I did not retire until work was no longer fun and my net retirement income would MORE than equal 100% of my working net income.
The best paragraph in the article was the last one, where he disclaims everything he suggested we talk with a financial planner or do extensive research on our own. I personally believe doing extensive research on our own is the best path, but realize that some will need to seek the advise of a "professional" - just be careful to understand everything he/she is offering before doing it.
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