Saving for Retirement
En Route to Easy Street
Here's how much you need to retire comfortably -- plus painless ways to get there, even if you're just getting started saving.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 29, 2006
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Editor's note: This article appears in Kiplinger's special issue Success With Your Money.
At the rate they're going, Jennifer and Brian Reilly will be leading a life of travel and leisure long before their peers can even think about retiring. "We don't want to work forever," says Jennifer, 30. "We want to retire as soon as possible and as comfortably as possible."
Toward that end, Jennifer and Brian, 35, contribute 12% of their salaries to their retirement plans at work -- more than enough to capture all of their employers' matching contributions. But they don't stop there. They also contribute the maximum $4,000 a year to their Roth IRAs through monthly automatic deposits. That will give them tax-free income in retirement. (Roth IRAs offer a way to diversify employer-based retirement plans, from which withdrawals are taxed at your top rate.)
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The Reillys own a comfortable three-bedroom home in the Takoma Park suburb of Washington, D.C., and have a combined income of nearly six figures. What sets them apart is their ability to live well below their means and free of debt.
For example, they take full advantage of free museums, concerts and recreational facilities in the nation's capital and buy used furniture and baby equipment on eBay. They own one car, a paid-for 1997 Subaru, and share a nanny with another family during the three days that Jennifer works as a nutritionist at the nonprofit Cancer Project. Brian, a marketing manager for an architectural firm, takes the subway to work and pays his transportation expenses with pretax money deducted from his paycheck.
In addition to allocating 22% of their gross income to retirement savings, the Reillys contribute regularly to a college fund for their infant daughter, Keller. They add $100 a month to an old-fashioned rainy-day fund in an ever-so-modern online bank account at HSBC that was recently paying 5.05%.
Brian calculates that if he keeps saving at his current rate -- and if his investments earn an average of 10% a year -- his 401(k) alone will be worth $1.2 million by the time he's 60. And that doesn't include the future value of Jennifer's 403(b) plan or either of their Roth IRAs.
The 15% target
As retirement super-savers, the Reillys are well ahead of other people their age. Nearly 40% of workers ages 26 to 41 don't even participate in their company 401(k) plans, according to a recent study by Hewitt Associates. At a time when traditional pension plans are disappearing, it's more important than ever to take advantage of workplace-based retirement savings plans, particularly if your employer matches your contributions.
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HOW MUCH IS ENOUGH? | |||
Start with the rule of 25A conservative rule of thumb suggests that if you withdraw only 4% -- or one twenty-fifth -- of your retirement nest egg during the first year and adjust subsequent annual withdrawals to compensate for inflation, you'll never outlive your money. Another approach is to estimate how much you'll need to withdraw from savings during your first year of retirement and multiply that amount by 25 to determine your target number. For a bare-bones budget, you would need only half as much, or 12.5 times your initial withdrawal. Your personal number is probably somewhere in between. Age: 45 *Assuming current salary increases 1.5% each year until age 65. †Social Security income of $19,380 based on Social Security Administration data plus a hypothetical pension income of $25,213. | |||
Christine Fahlund, a senior financial planner at T. Rowe Price, recommends that workers try to save 15% of their gross salary (including employer matching contributions) in order to replace 50% or more of their income in retirement. The later you start, the more you'll have to save.
Most retirees will also receive Social Security benefits, which could replace an additional 20% to 30% of preretirement income. That would boost total income in retirement close to the 75% to 85% replacement figure generally recommended to maintain your lifestyle. For the average wage earner, Social Security replaces about 42% of preretirement income; that figure is lower for higher-income workers.
Like many in their generation, Brian and Jennifer aren't counting on Social Security -- another reason they're saving so diligently on their own. Financial planners generally recommend that you restrict your withdrawals to 4% of your total savings during your first year in retirement and gradually increase withdrawals to keep up with inflation. At that rate, you're virtually guaranteed not to run out of money. So if you need to tap $40,000 in savings in your first year of retirement, you will need a $1-million nest egg (4% of $1 million is $40,000; see the box to the right, plus retirement calculators at kiplinger.com/links/success).
Pain-free saving
When you're just starting to save, the amount you contribute to your retirement account has a larger impact on your balance than does investment performance. A recent study by Putnam Investments found that bumping up contributions by just 2% would have doubled retirement wealth after 15 years compared with relying solely on investment performance.
As your balance increases over time, however, investment performance becomes increasingly important. But many people don't want to manage their own retirement plans. As a result, do-it-yourself 401(k) plans are giving way to do-it-for-me options, collectively called automatic 401(k) plans.