How Much Do You Need To Retire?

Picturing yourself as a retiree may be hard if not impossible. But if you could envision those future years, you'd probably see a life full of activity and decades of health, happiness, and prosperity. No rocking chairs and lap shawls need apply.

Your Retirement Lifestyle Is In Your Hands

The reality, however, is probably somewhere in between. The problem with the picture is that the pleasure and comfort of your later years depend, to an ever-increasing degree, on the action you take today.
So many changing facets of the American workplace have made it more important than ever to take control of your financial future. By investing now with a long-term focus, you can greatly improve your chances of having a fulfilling retirement.
Americans used to count on a pension and Social Security to get them through those "golden years." These days, people change jobs more often, sometimes forgoing pension benefits. They may also rely on dual incomes and manage their own retirement funds through defined contribution plans. By most estimates, you'll generally need at least 70% of your final working years' income each year to maintain your lifestyle after retiring.

Sources of Retirement Income

The above chart represents a breakdown of typical income sources for a current retiree. Source: Social Security Administration, 2010.

Start Investing Now

The accompanying pie chart shows the importance of saving now toward a retirement fund. Not only are Social Security benefits less significant, but the sums are diminishing and the age at which you can begin to receive benefits is higher. You can contact Social Security at (800) 772-1213 to learn what you can expect in benefits, and when. Benefits are calculated on your earnings, with certain variable factors.

Alas, the responsibility for the bulk of your nest egg rests with you. Social Security represents approximately 36% of the total income received by retirees, and one-third of all retirees rely on Social Security for 90% or more of their income.*

Beware: The High Cost Of Healthcare And Inflation

As you begin thinking about how much you'll need for a comfortable retirement, you may be startled to learn the impact of inflation. At an average annual inflation rate of 3%, your cost of living would double every 24 years.* Your annual income will need to increase each year, even during retirement, in order to keep up with the gradual rise in prices of everyday goods.
You'll also have to consider the likelihood of increased medical costs and health insurance as you grow older. The average nursing home stay, for instance, now costs more than $83,000 per year and could rise to almost $150,000 per year by 2030, assuming an annual inflation rate of 3%.*
*Source: Standard & Poor's, 2010.

The Risk Of Relying On Social Security And Your Pension

Now that you have an idea how much you'll need to finance your retirement years -- of which there can easily be 25 or more -- you may better understand the importance of building your assets.
Many of us may need at least 70% of our annual pre-retirement income to live on each year after we retire. Of this, only about 54% comes from Social Security and qualified retirement plans, including pensions, for today's average retiree.* The rest must come from other sources, including personal investments, such as mutual funds and other investment products. Find out how close you are to meeting your goal by completing the exercise below.

*Source: Social Security Administration, 2010. Based on average annual benefit in 2008 (most recent report published) for all retired workers.

Your Retirement Needs: A Worksheet

1. Estimate your last working year's salary. Multiply your current salary by the inflation factor from the table below, based on the number of years you have until retirement. _____________ Example: If you are currently making $40,000 and have 20 years until retirement, your formula is $40,000 x 1.81 = $72,400 2. Estimate 80% of your last working year's salary. ____________ Example: $72,400 x .80 = $57,920 3. Estimate the amount that you'll need from your savings and investments by multiplying line 2 by 12.591. _____________ Example: $57,920 x 12.591 = $729,254 4. Enter the amount of your current savings and investments and multiply it by the growth factor from the accompanying table. This is what your savings would be worth by the time you reach retirement, assuming a 5% return compounded annually. _____________ Example: If you currently have $11,000 x 2.65 = $29,150 5A. If line 4 is larger than line 3, congratulations! You may be on your way to meeting your retirement goal. Keep saving! B. If line 3 is larger than line 4, subtract line 4 from line 3. Enter that amount here. This is the additional amount you may need. _____________ Example: $729,254 - $29,150 = $700,104 C. Divide line 5B by the multiplier in the table below for the number of years to your retirement. The result is the approximate amount you may want to set aside each year.*** _____________ Example: $700,104/34.72 = $20,164 Years to Retirement Inflation Factor Growth Factor Multiplier 5 1.16 1.28 5.80 10 1.34 1.63 13.21 15 1.56 2.08 22.66 20 1.81 2.65 34.72 25 2.10 3.39 50.11 30 2.43 4.32 69.76 35 2.81 5.52 94.84 ***Assumes 3% annual inflation and a 5% annual return.

Traditional pensions are estimated to supply only 18% of retirement needs, according to the Social Security Administration. Add that to the income you might expect from Social Security and you'll probably still fall far short of your goal. A reduced standard of living for a quarter century or more is hardly the stuff "golden age" dreams are made of.

Current Tax Deferral And Time: Two Allies Working For You

Time can help you, due to the potential benefit of compounding. The other great benefit in preparing for retirement is tax deferral. Using investment vehicles such as 401(k) plans or individual retirement accounts (IRAs), you can defer paying current taxes on your earnings until you are retired and potentially in a lower tax bracket. Meanwhile, depending on the type of retirement account and your current income, your contributions may be tax-deductible, helping reduce current tax bills. Keep in mind that withdrawals made prior to age 59½ are taxed as ordinary income and may be subject to a 10% federal penalty.
Example. An investment of $10,000 could grow to more than $100,000 after 30 years, at an annual hypothetical return of 8%, if all the returns were reinvested and the account grew tax-deferred. As with all hypothetical examples, individual investor results will vary. This example does not represent the performance of any specific investment, and the earnings would be subject to taxation upon withdrawal at then-current rates and subject to a 10% federal penalty for early withdrawal made prior to age 59½.
The more time you have until retirement, the more fortunate you may be. Delaying just months -- never mind years -- can reduce your results.
Example. Jane begins investing $100 a month in her employer-sponsored 401(k) plan when she's 25. Mark does the same - beginning when he's 35. Assuming a hypothetical 9% annual rate of return compounded monthly, when Mark retires at 65, he'll have $183,074. Jane will have $468,132.
While this is only a hypothetical example and does not represent the performance of a specific investment, you can see the remarkable difference starting early can potentially make.

Invest Early And Often

By starting early and investing systematically you could potentially benefit from the potential of compounding and tax deferral.
Another advantage of today's retirement planning options is that you have some control over how your money is invested. Investment plans need to offer a variety of options because different people have different degrees of risk they will accept, as well as varying time frames they intend to hold their investments. A portfolio can be diversified to take these factors into account. It's a wise idea to consult a financial professional for complete information.

Points To Remember

1. The rising cost of living means you need to plan on an annual retirement income that could be substantially higher than what you spend now.
2. You may have higher expenses in some areas such as medical care, but lower expenses in others.
3. You'll generally need at least 70% of your final working years' salary in each year of retirement.
4. Retirement income may be made up of pension benefits, Social Security benefits, personal savings and investments, and income from part-time work.
5. Your financial professional can help you develop an estimate of your needs and a plan to help you accumulate a retirement fund to help provide income you'll need.