Retirement in the U.S is characterized by the age at which government health benefits and Social Security kick in. Currently, the full benefit age is 66 years and two months for people born in 1955, and will gradually rise to 67 for those born in 1960 or later. If a person has saved aggressively their whole career, is healthy, and can afford private health insurance, they will likely quit working and retire sooner than age 66.
By 2024, the U.S. Bureau of Labor Statistics projects that the American labor force will grow to approximately 164 million people. This projection includes about 41 million people who will be age 55 and older—of whom 13 million are expected to be ages 65 and older.
Planning for Retirement
In a perfect world, the 41 million baby boomers still in the workforce would have been planning for retirement since the 1980s; having no major health crises, debts, or legal problems; buying and holding profitable, diverse investments with financial allies who didn't defraud them of their hard-earned money; and working steadily all the while.
Unfortunately, more "retirement-age" individuals are projected to work into their 70s than at any other time in American history, competing alongside all younger members of the workforce for well-paid positions.
If you don't want to fall behind on your retirement savings, make sure you have a plan. Here's what you need to know about retirement planning in six steps.
1. Figure Out How Much You Need
Calculate how much money you'll need to support your cost of living when you retire.
One general estimate says that you should aim for 8% of your current income. If you make $100,000 per year, for example, you should aim for a retirement income of $80,000.
When considering this calculation make sure to note that a person who makes $100,000 a year and spends every dime is different than a person who makes $100,000 a year and lives on 30% of this income.
Here's a different approach: base your assumption on how much you currently spend, not how much you currently earn.
Assume that the amount you spend right now will be roughly equal to the amount you spend when you retire. You may be free from some current expenses like your mortgage during your retirement years, but you'll probably also pick up new expenses like travel and additional health care costs.
2. Multiply by 25
Multiply the amount you need each year in retirement by 25. This is how large your portfolio should be, assuming you have no other sources of retirement income.
If you want to live on $40,000 per year, for example, you'll need a $1 million portfolio ($40,000 x 25). If you want to live on $60,000 per year, you'll need a $1.5 million portfolio. However, do not think of these amounts in static form. Think of the time value of money. This means you would need that amount over time as a future value. So you need to save enough each year to yield a future value of around $1 million at year 1 of retirement.
If you use a financial calculator, you can set the parameters like this, for instance:
- Annual Payments After Retirement = $40,000
- Years To Live After Retirement = 25
- Real Rate of Return = 3% (after inflation)
- Future Value at Death = 0
Computing the Present Value (money in the portfolio at time of retirement) yields $859,488.80, or roughly $1 million.
3. Discover What Social Security Will Pay
Go to the U.S. Social Security website and use their estimator tool to get an idea of how much you'll collect in retirement.
Add this figure to any other sources of retirement income that you may have, like a pension or rental income, then subtract from the annual retirement income you want from the total.
Let's say you want to live on $60,000 in retirement, and Social Security pays you $20,000 per year on top of a small ($5,000 per year) pension. This means $25,000 of your retirement income will come from other sources. Only $35,000 needs to come from your portfolio. Therefore, you'll need $875,000 ($35,000 x 25) in your portfolio, not $1.5 million.
4. Use a Retirement Calculator
Use a retirement calculator to find out how much money you'll need to save each year to accumulate your target portfolio.
Assume that you're 30, you currently have $20,000 saved, and you want to retire at 65. You want a retirement income of $70,000, of which $25,000 will come from Social Security and the other $45,000 will come from your portfolio. For the sake of this example, assume a 4% inflation rate, 25% tax rate, and 7% rate of return on your portfolio investments.
Under these conditions, you'll need to put aside $24,000 per year to have a good shot at your retirement portfolio lasting until you turn 99.
Crunch the numbers for your specific situation to see how much you'll have to save to meet your goals.
5. Start Saving Right Now
Put your plan into action as soon as possible, and remember that it's never too late to start saving and investing your earnings. Trim your grocery bill, dine at restaurants infrequently, take a frugal vacation, and use lots of other money-saving tips to help move more cash into your retirement accounts each year.
6. Diversify Your Investments
Invest the money that's in your retirement portfolio based on your age, your risk tolerance, and your income goals. As a rule of thumb, 110 minus your age is the percentage of the money you should keep in equities (stocks), with the rest in bonds and cash equivalents. If you're 30, for example, keep 110 - 30 = 80% of your portfolio in stocks, with the rest in bonds and cash, and rebalance yearly.