As the middle of the year approaches, it may be a good idea to review aspects of your financial plan to assess whether they need a fresh start. Look at the performance of your 401(k)s and individual retirement accounts, for example. You need to make sure you are on track for a comfortable retirement that meets your life goals. Retirement savings are an essential part of a financial plan, no matter what your age.
This year may have been especially hard on your retirement savings. First, the stock market plummeted in March 2020 due to the economic effects of the coronavirus pandemic. It entered bear market territory around the middle of the month (defined as a loss of 20 percent or more). If part of your retirement savings is invested in the stock market, you may well have less in your portfolio than you did at the beginning of the year.
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Second, the coronavirus pandemic had significant economic effects beyond the stock market. U.S. unemployment skyrocketed beginning in March 2020, as many businesses were shut down. If you worked in a business that was affected, you may have been furloughed or had your hours reduced. The resulting drop in income may have affected your ability to save for retirement.
Third, the pandemic is not yet over, nor is the economic and financial uncertainty it caused. Unemployment is still high. The survival of affected businesses is not guaranteed. Entire sectors, such as transportation and restaurants, may be on shaky ground for some time. The uncertainty could affect your plans going forward. If you are young, saving for retirement may not seem as pressing as other concerns. If you are near retirement age, on the other hand, you may be wondering what to do.
All the more reason to make a fresh start on your retirement plans. Here’s how:
Calculate How Much You Need at Retirement
People save for retirement for two basic reasons. First, you need to have sufficient assets to not run out of money before you die. Second, you need to be able to achieve retirement (and life) goals based on the assets and income available during your retirement.
Assess your goals first. If you want to travel extensively, for example, your financial plan might be very different than that of a person who wants to start a business.
After determining what your retirement goals are, estimate your expenses in retirement. As a rule of thumb, people generally need roughly 80 percent of their pre-retirement income to meet expenses once they retire. But that can vary based on your likely expenses and goals. Will your mortgage be paid off, for example, or are you likely to still carry a mortgage payment? Do you plan to travel more extensively once retired? How much will healthcare cost? Many of our clients desire 100% or more of their pre-retirement costs as they fully enjoy their retirement years and the efforts of their hard work.
Once you have a budget estimate, calculate how much your Social Security benefits are likely to be at retirement. The U.S. average is $1,503 per month as of 2020. Subtract your own estimated amount from your estimated budget. If you expect to have any other income (from a pension or rental properties, for example) subtract those estimated amounts from your estimated expenses as well.
The number left over is the amount that your retirement savings will need to cover. If, for example, you estimate that you’ll need $6,500 per month in retirement, and your Social Security benefit estimate is $1,500, you will need savings that will yield $5,000 per month in retirement, or $60,000 per year.
When working with Financial Freedom Fee-Only Wealth Management, we believe it is never too early to begin your retirement planning. Based on your unique situation and goals we can provide the advice you need to accomplish them.
How Much Do You Need to Save?
Once you have a ballpark figure of what you’ll need in retirement, you have a goal to save toward. How much do you need to save in your retirement funds to meet a goal of $60,000?
One rule of thumb for retirement savings is to save 25 times your estimated yearly needs. For an annual income of $60,000, then, you would need a savings of $1.5 million at retirement age. Are you currently on track for a savings and appreciation that would result in that the amount you need?
Your retirement savings should be withdrawn in retirement at a rate that ensures you won’t run out of money before you die. A frequently used corollary to the 25 times savings is the 4 percent rule. According to the 4 percent rule, people who withdraw 4 percent of a portfolio every year in retirement should be able to live for 30 years without running out.
In other words, 4 percent of $1.5 million is $60,000. If you plan to retire at 66, you’d be able to receive roughly $60,000 annually until you hit the age of 96. If you expect to live longer than that, the 4 percent rule (or your savings) should be adjusted.
While the rule of 25 and 4 percent “rule of thumb” are useful general approaches, given the importance of retirement planning and ensuring that you will have a comfortable retirement without concerns for money, we believe that utilizing a more comprehensive approach with the development of a comprehensive financial plan including detailed retirement modeling using Monte Carlo simulation is the most prudent way to develop and confirm your retirement plans. Once this detailed planning is completed, the rule of 25 and 4 percent “rule of thumb” are excellent ways to re-affirm the plan that you have.
Decide Your Asset Allocation
To maximize retirement savings, you may want to consider allocating the assets in your portfolio with an eye to your age while also considering your tolerance for risk. Stocks historically provide the highest rate of return – roughly 10 percent each year, on average, over the 1926 to 2014 period. But stocks also carry the most risk; market fluctuations can send a portfolio down as well. Bonds and cash instruments provide less of a return, but also more stability.
As a result, portfolios often combine stocks, bonds and cash instruments. It would likely make a lot of sense for younger people to have far more stocks than bonds versus someone older and preparing to start retirement. While there are certainly some “rules of thumb” out there for asset allocation (the age based 110 rule as an example), we believe that planning for a successful retirement requires far more than general “rules of thumbs” that may or may not relate to your individual situation.
That is why it makes sense to enlist the help of a professional financial advisor. Financial advisors can run projections to calculate your specific retirement needs. They can carefully craft a plan that makes sense for you, versus a cookie-cutter ‘rule of thumb’. A successful retirement plan is just too important to you and your family to use a cookie-cutter ‘rule of thumb’.
Saving for retirement can be complicated. The CERTIFIED FINANCIAL PLANNER™ professionals at Financial Freedom Fee-Only Wealth Management can ensure that you are prudently saving for retirement as part of a balanced financial plan. Contact us today for a no-strings-attached complimentary consultation.