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How Much Do I Need to Save?
Many Americans realize the importance of saving for
retirement, but knowing exactly how much they need to save is another issue
altogether. With all the information available about retirement, it is
sometimes difficult to decipher what is appropriate for your specific
situation.
One rule of thumb is that retirees will need approximately
80% of their pre-retirement salaries to maintain their lifestyles in
retirement. However, depending on your own situation and the type of
retirement you hope to have, that number may be higher or lower.
Fortunately, there are several factors that can help you work
toward a retirement savings goal.
Retirement Age
The first factor to consider is the age at which you expect
to retire. In reality, many people anticipate that they will retire later
than they actually do; unexpected issues, such as health problems or
workplace changes (downsizing, etc.), tend to stand in their way. Of course,
the earlier you retire, the more money you will need to last throughout
retirement. It’s important to prepare for unanticipated occurrences that
could force you into an early retirement.
Life Expectancy
Although you can’t know what the duration of your life will
be, there are a few factors that may give you a hint.
You should take into account your family history—how long
your relatives have lived and diseases that are common in your family—as
well as your own past and present health issues. Also consider that life
spans are becoming longer with recent medical developments. More people will
be living to age 100, or perhaps even longer. When calculating how much you
need to save, you need to factor in the number of years you will spend in
retirement.
Future Health-Care Needs
Another factor to consider is the cost of health care.
Health-care costs have been rising much faster than general inflation, and
fewer employers are offering health benefits to retirees. Long-term care is
another consideration. These costs could severely dip into your savings and
even result in your filing for bankruptcy if the need for care is prolonged.
Factoring in higher costs for health care during retirement
is vital, and you might want to consider purchasing long-term-care insurance
to help protect your assets.
Lifestyle
Another important consideration is your desired retirement
lifestyle. Do you want to travel? Are you planning to be involved in
philanthropic endeavors? Will you have an expensive country club membership?
Are there any hobbies you would like to pursue? The answers to these
questions can help you decide what additional costs your ideal retirement
will require.
Many baby boomers expect that they will work part-time in
retirement. However, if this is your intention and you find that working
longer becomes impossible, you will still need the appropriate funds to
support your retirement lifestyle.
Inflation
If you think you have accounted for every possibility when
constructing a savings goal but forget this vital component, your savings
could be far from sufficient. Inflation has the potential to lower the value
of your savings from year to year, significantly reducing your purchasing
power over time. It is important for your savings to keep pace with or
exceed inflation.
Social Security
Many retirees believe that they can rely on their future
Social Security benefits. However, this may not be true for you. The Social
Security system is under increasing strain as more baby boomers are retiring
and fewer workers are available to pay their benefits. And the reality is
that Social Security currently provides only 20% of the total income of
Americans aged 65 and older with at least $44,000 in annual household
income.1 That leaves 80% to be covered in other ways.
And The Total Is…
After considering all these factors, you should have a much
better idea of how much you need to save for retirement.
For example, let’s assume you believe that you will retire
when you are 65 and spend a total of 20 years in retirement, living to age
85. Your annual income is currently $80,000, and you think that 75% of your
pre-retirement income ($60,000) will be enough to cover the costs of your
ideal retirement, including some travel you intend to do and potential
health-care expenses. After factoring in the $12,000 annual Social Security
benefit you expect to receive, a $10,000 annual pension from your employer,
and 4% potential inflation, you end up with a total retirement savings
amount of $760,000. (For your own situation, you can use a retirement
savings calculator from your retirement plan provider or from a financial
site on the Internet.)
The estimated total for this hypothetical example may seem
daunting. But after determining your retirement savings goal and factoring
in how much you have saved already, you will be able to determine how much
you need to save each year to reach your destination. The important thing is
to come up with a goal and then develop a strategy to help reach it. You
don’t want to spend your retirement years wishing you had planned ahead when
you had the time. The sooner you start saving and investing to reach your
goal, the closer you will be to realizing your retirement dreams.
1) Income of the Population 55 or Older, 2004,
Social Security Administration, 2006. Breakdown based on people aged 65 and
older with at least $44,000 in annual household income.
© 2007 Emerald Publications
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