Some Americans take a backward approach when it comes to planning for retirement. They spend the bulk of their careers avoiding all worry about their future financial prospects, yet they have a total meltdown when they realize — a decade or a few years out — that they are dramatically underprepared for the retirement they want.
Unfortunately, this type of underpreparedness is way more common than people realize. In fact, a 2020 study from Allianz Life revealed that more than half of Americans have serious "savings concerns." For example:
- 55% of non-retirees said they are worried they won't have enough savings to retire
- 60% of non-retirees said they are worried of running out of money before they die
- 42% of study respondents who were within 10 years of retirement said they do not have any extra funds to save right now
- 32% of near-retirees said they are so far behind on their retirement savings goals they won't be able to catch up
If you don't want to wind up in a situation where you are short on the funds you need to enjoy your golden years, your best bet is coming up with a comprehensive retirement plan now. After all, waiting any longer will only make the pain worse and give you even less time to invest and see your savings grow.
While you can work with a financial advisor to plan for retirement (and perhaps you should), there are plenty of steps you can take now, on your own. This basic framework can help you get started.
Step 1: Determine Your Retirement Goals
The first step in retirement planning is thinking about the type of retirement you want to have and how much it will cost. After all, the type of lifestyle you envision for your retirement plays a huge role in your next best steps. You'll need a lot more money if you want to retire in luxury and travel the world, but you could get by on less if you want to remain at home and enjoy the simple life.
Looking at how much money you earn now is a good way to gauge how much you'll want to have in retirement. If, for example, you're currently living a lifestyle you're happy with and able to save 20% of your income, then it's somewhat reasonable you could live on 80% of your current earnings in retirement (after accounting for inflation).
However, there are other factors that can come into play. For example, someone who plans to have a paid-off home in retirement may be able to shoot for a lower retirement savings goal since future housing costs would be limited to property taxes, homeowners insurance, maintenance and repairs.
Takeaway: Look at your current income and decide how you want your retirement income to stack up. Do you need the same amount of income in retirement, or will you be able to get by on less?
Step 2: Assess Your Current Spending
If you could find a few areas of spending to cut without dramatically altering your lifestyle, you would be doing yourself a big favor. After all, cutting your spending can help push you toward a fruitful retirement in more than one way.
First, cutting spending makes it easier to save a larger percentage of your income for retirement. Second, lowering your average spending and keeping it low means you can lower the dollar figure you're shooting for when you retire.
Most people can find at least some areas of their budget to slash, whether that includes paying cars off and driving them longer (instead of constantly trading in), dining out less, living in a modest home, cutting cable or shopping sales at the grocery store.
Also remember that, when it comes to cutting spending, it does not have to be all or nothing. Finding even a few hundred dollars in savings each month can help you reach your financial goals faster than you otherwise would.
Takeaway: Look for areas of your life where you could be spending less. If you're able to find some savings and divert those funds to your retirement investment accounts, you can reach your retirement goals faster.
Step 3: Figure Out How Much You Need to Save
When you look at most retirement calculators, the majority expect you'll need 50% to 80% of your current income in retirement — and that you'll need that money to last for anywhere from 20 to 40 years. With that in mind, one general rule of thumb people use to plan for retirement is the "rule of 25." This general rule says you may be able to retire when you have 25x your income saved for retirement, which should let you withdraw around 4% each year without draining your accounts too soon.
How does this figure look in real world terms? If you and a spouse earn $100,000 per year, you might strive to build up $2.5 million in invested assets to use for retirement. Once you reached that goal, you could live on $100,00 per year from your accounts and your investment returns would theoretically help your money grow so it lasts well beyond 25 years.
Keep in mind that this is a general rule of thumb to shoot for, and it doesn't take key items like inflation or taxes into account. You can also tinker with this figure so it makes sense with your retirement goals.
Maybe you want to live a luxurious retirement or one where you never have to wonder if your money will last. In that case, you could boost your savings goal to 30x or 35x your current income.
Or perhaps you plan to be entirely debt-free and live frugally in retirement. In that case, you may want to shoot for the lower end of 25x your income, or even on the lower end of 25x what you plan to spend in retirement.
Takeaway: Create a rough goal for your "retirement number," keeping in mind that you might want to adjust this figure up or down later on.
Step 4: Create an Investing Goal
Once you have a retirement number in mind, you have to figure out how much you might need to invest to reach your goal. This part is tricky since there are so many factors out of your control. For example, what kind of investment returns will you enjoy for the next 20 to 30 years? Nobody knows for sure, so all you can do is make an educated guess.
If you look at the returns of a major index like the Dow Jones Industrial Average, you'll see that annual returns are all over the place. The Dow Jones went up 7.25% in 2020 and 22.34% in 2019, yet the decade that led up to 2018 was tumultuous to say the least. However, the average return of the Dow Jones over the last 30 years currently sits at 6.758% when adjusting for inflation and reinvested dividends.
While your investment plan may do better or worse, this figure is a good place to start. From here you'll want to use a compound interest calculator to figure out what it will take to reach your retirement number. We suggest this one from Investor.gov.
With a compound interest calculator, you can figure out how much you need to invest each month to reach your retirement number. Here's an example:
Let's say you and your spouse are 30-years-old and currently earning $100,000 per year. You are also hoping to save 25x your income before you retire, and you currently have around $180,000 in retirement savings.
You believe you have 30 more working years before you retire, so you play around with a compound interest calculator to see how much you need to invest each month.
When you plug in the numbers, you quickly find that you could invest $2,000 per month ($24,000 per year), receive a return of 6% for 30 years, and retire with more than $2.9 million dollars. If you were more aggressive with your savings and boosted your monthly goal to $3,000, on the other hand, you could retire with almost $3.9 million dollars.
This is just an example, but you should be able to see how you could apply to this strategy to your own income and goals.
Either way, you also have to figure out where to invest your money. The first place to start is going to be any tax-advantaged retirement plan you have, such as a workplace 401(k) or a self-employment retirement plan like a Solo 401(k) or a SEP IRA.
You can also look into other retirement accounts like a traditional IRA or a Roth IRA.
Any additional funds you want to invest for retirement can be placed into a brokerage account, which lets you invest in stocks, bonds and other securities over any timeline you want.
Takeaway: Figure out how much you need to invest and decide which retirement plans you want to use. If you need help deciding on investments or retirement accounts, reaching out to a financial advisor can make sense.
Planning for retirement is considerably easier when you start early and consistently save for the future you want. Likewise, waiting until you're close to retirement to start planning is the best way to make sure you fail.
The steps we outline in this guide provide a basic framework to start you on the path toward the future you really want. However, don't be afraid to reach out for professional advice if you need it.