With no further ado we bring you:Hello, MTM readers! I’m Femme Frugality, a mother who blogs about money. I’ve teamed up with Janene and Christine to answer some of your money questions, and I’m really excited about it. This month’s question comes from Lisa at The Dose of Reality:
Although we’re far from retirement age, I still wonder: how do you determine how much money you need for retirement? Right now we contribute to our 401Ks (which took a beating in 2008 in a way that will make me rock in the corner if I think about it too long) but we’re primarily saving for our kids’ college right now. Once they go we’ll be able to save more toward retirement, but will that be enough time to avoid working until we’re 90? How do we know how much we need to safe up for retirement?
Well, Lisa, I’ve just started getting into the topic of retirement myself. I’ve been reading a lot lately, but feel a little bit inadequate answering this particular question. Fortunately, I have some amazing blogger friends who know A LOT about retirement and how to get there. They were all happy to see this inquiry come up!
You may remember Done By Forty from the tax post last month. (The title of his blog is actually the age he’d like to be financially independent by.) We’ll start with his advice:
The standard advice is to use the 4% Rule: your annual expenses should represent 4% of your retirement accounts at the time you retire. So, if you spend $40,000 annually when you retire, you would want a $1,000,000 nest egg (as $40k is 4% of a million dollars). Then, you can ‘safely withdraw’ that same $40,000 every year (adjusted for inflation), with your investments earning enough each year to cover your withdrawal and to keep up with inflation. At least that’s the hope. Jason Hull wrote an excellent article on the 4% Rule here, which also explains the risks of such rules of thumb. As always, the specifics of your situation should govern your decision.
Understanding that the 4% Rule is just a rule of thumb, the first step would be to understand the amount of money you think you will need each year in retirement. Keeping track of your annual costs now is good, but they are likely to change over time. Do you think you will pay off your mortgage before retiring? Will you need to purchase healthcare on the open market? After estimating that annual expense figure, be sure to account for inflation. For example, let’s say you calculate you will need $40,000 annually; due to inflation, in 10 years, you may need over $50,000 to make the same purchases. Once you have that inflation adjusted figure, you can use the 4% Rule to calculate the target value of your nest-egg.
It’s no substitute for sitting down with a financial planner, but it can give you a ballpark figure to aim for in the years and decades leading up to retirement.
Save. Spend. Splurge. is a mother-to-be and very well versed in the world of investing.
To determine how much you need for retirement, you need to first determine these things:
1. What you plan on doing in retirement
2. How much you spend now to maintain your current lifestyle and if you plan on decreasing those expenses (e.g. your house will be paid by the time you retire) or increasing them (traveling for instance)
3. When you plan on retiring (e.g. age 65 means you need to save more than let’s say at age 70)
Essentially, before you know how much you need to save, you need to know how much you want to spend.
There is no magic formula or answer of how much you need to save for retirement but you can use these methods and get a range of answers by which you can use as an average:
A. Using your current salary as a benchmark
By age 35, your goal is to save an amount equal to your annual pay.
By 45, you will want to have saved about three times your salary, rising to five times your salary by 55.
Typical wage earners should aim to save at least eight times their final annual pay to be sure they can afford basic living expenses in retirement.
B. Using your net worth as an indicator to see if you are on track for an average retirement
Your Age x 10% x Your Current Salary = What your net worth should be
I would use this method with caution because if you have not diversified your assets and your net worth is tied up in one large asset (usually a house), it is far riskier as recent times have demonstrated to have to depend on the housing market to provide you with a nest egg when you go to retire.
C. The rule of 30
You should take how much you need each year for retirement, and multiply that by 30.
D. Using calculators online to get a range of answers, and then averaging them
Finally, it sounds like you are prioritizing your kids’ educations over your future which is admirable and selfless, but I’d caution you to consider that you may be doing them and yourselves a disservice by not first securing your own financial future to make sure that you are not going to burden them with the emotional and financial cost of (perhaps) having to support their senior parents who sacrificed everything including their retirement to pay for their education.
That is not to say that you should not save for your childrens’ education at all, but keeping a perspective of what the end goals are and having a balance, is important. To put it bluntly, would you be willing to work until the day you die in order to pay for your children’s education now?
And on a similar note, advice from a mother who has met her retirement goals early and sent her child to college, Barbara Friedberg.
These are great questions to be pondering right now, with no easy answers. If you’ve lived more than a decade or two, you understand that life is unpredictable. That said, you can make some decisions now, to make your future life financially secure.
Save for Kids College or Retirement?
Regarding saving for college and retirement, I recommend you do both simultaneously.
Do not wait to save for retirement until your kids are in college. The reason is because you will have sacrificed the next 18 years of awesome compounding of returns to grow your wealth.
The Short Answer to “How Much Do I Need at Retirement”
Fidelity.com recommends a nest egg of 8 times your final salary. So if your final salary was $100,000 then you would need $800,000. Personally, I believe there are money behaviors to put in place now that will secure your future and that setting a precise number is difficult if not impossible. You may want to set a ballpark estimate now, but understand it will change as time goes on.
Quick investing primer:
Compounding of returns is the best way to grow your wealth. In short, compounding means that your money makes more money for you.
Invest $3,000 (or $250 per month) per year starting at age 25 in a diversified portfolio of index funds earning an average annual return of 7%. At age 65 you contribution of $120,000 will be worth more than $640,000. That is the power of compounding.
Where to begin right now.
Step 1: Contribute the maximum to your workplace retirement account if at all possible.
If you can’t swing that, contribute at least enough to get the employer match.
Choose a diversified portfolio of index funds, in line with your risk tolerance.
Stocks and bond returns are volatile (remember 2008), but if you continue investing through ups and downs, your annual return will likely be between 6-8%.
Step 2: Open a 529 College Savings Plan and start funding it a bit every year.
Worry less about calculating an exact number to have saved at retirement.
Focus on creating a life filled with what matters to you. Spend on things that give you value, and prioritize saving. It is worth delaying gratification to have a rich life now (filled with friends and family) and in the future.
How We Reached Our Retirement Goals 15 Years Ahead of Schedule
I did something quite drastic in my 20’s which has made the later decades awesome. I contributed the maximum to my workplace retirement account, my husband contributed the maximum to his, and we funded Roth IRA’s and contributed to a 529 plan.
We also had very modest income’s starting out.
We lived very conservatively, way below our means.
Now, as we are 15 years from retirement, we have reached our retirement goals. Our child graduated from college and we have room to splurge.
I know this uber-saving and investing is not for everyone, but if you are willing to save and invest between 10 and 20 percent of your income, starting in your 20’s or 30’s, you will be well prepared to help fund your kid’s college and your own retirement.
It’s not rocket science, it’s all about smart money choices.
And if you want to do some number crunching, there are scores of retirement planning calculators online.
And if all that leaves you feeling overwhelmed, Joe Saul-Sehy from Stacking Benjamins, who has a couple of kids in college, has some great advice to keep you on track without turning your hair grey prematurely:
There’s good news! If you’re far away from retirement, realize that planning retirement is a process, not a single event. That’s going to work in your favor.
There are many calculators on the internet to help you figure out “your retirement number.” That part’s fairly straightforward. Once you’ve got your number, though, you’re the driver on a trip to retirement….and you’ll need to adjust as you get more information. Sometimes the market will help you out and other times it’ll hurt.
That’s why I like to think in terms of milestones. I wasn’t only interested in “the retirement number,” but I also wanted to know what the yearly little numbers are that we had to hit to achieve that bigger “end” number. Those closer milestones were less scary. Like someone smart once said, the best way to eat an elephant is one bite at a time.
As for saving primarily for college vs. retirement, I’d also recommend changing that around. There are many ways to help your kids get through college, but there isn’t any financial aid or grants for retirement. The power of compounding interest is a powerful tool you’re giving away by waiting until later.
Thank you so much, Christine and Janene for having me again! More Than Mommies readers, what are YOUR financial questions? You could be featured next month!