Most people make this decision according to when they will begin receiving Social Security benefits. Full retirement age (FRA) is 66 if born between 1943 and 1954. Full retirement age is 67 if born 1960 or later. You may choose to receive Social Security benefits as early as 62 but your benefit will be reduced by about 25%. This locks in your benefit amount for the rest of your life, although you will still receive cost of living adjustments. (COLA).
You also need to consider if you will continue to work while receiving benefits. At full retirement age, you may work as much as you like without penalty. But if working before full retirement age your benefit will be reduced if you hit certain dollar thresholds. If you delay benefits until age 70 your monthly amount will be about 32% greater than you would receive at full retirement age.
After considering your Social Security benefit and any other guaranteed income you expect, determine how much you would need monthly to meet your needs. Financial planners estimate that you will need anywhere between 70-85% of pre-retirement income. Also take into consideration that healthcare costs will rise as you age. Medicare, a federal health insurance program for those 65 and older, is divided into Part A, B and D. Medicare Part A only covers hospital care. You will need to purchase Part B for doctors and outpatient care. If you take prescriptions Part D will be another expense.
There is also the real possibility that you will need long term care. According to the Dept. of Health and Human Services 70% of Americans turning 65 will need long term care services in their lives.
This refers to the rate of return on your investments. This number varies widely depending on how your investments are allocated and the state of the stock market. Generally, stocks are more volatile than bonds. That's why you want to diversify your holdings and aim for earnings above the annual inflation rate. The return of your investments determines how long your money will last.
According to the US Social Security Administration, ssa.gov, “a man reaching age 65 today can expect to live on average until age 84. A woman turning age 65 today can expect to live on average until age 86.” So count on at least 20 years in retirement.
Inflation is basically an increase in the price of goods expressed by a percent. The higher inflation rises, the less your dollar can buy. All one needs to do is talk to one's grandparents and they will quickly recount the days of gasoline for $0.29/gal or a new three bedroom brick ranch for $20,000.
That's why, when taking inflation into consideration, the retirement calculator will indicate a higher amount needed to reach your goal.
The annual inflation rates fluctuates, but since 1992 the rate has remained below 4%.
The rule of thumb is that at age 35 you should have 1X your annual salary saved for retirement. At age 45 the number increases to 3X your current salary and age 55 the number is 5X your annual salary. By retirement age the number is 8X your annual salary. This may seem like a daunting amount, but there are some variables such as having no debt and having a paid mortgage during retirement that could reduce these amounts. If you ever have the urge to dig deep into retirement researching, check out the works of Wade Pfau and Kimberly Blanton.
If your current retirement savings are looking slim, here are some ways to fatten it up.
There are several vehicles to help you save for retirement. One of the most common is the 401K, a savings plan administered by your employer where you elect to deduct pre-tax money from your paycheck which is deposited directly into your 401K account. An added benefit is that most employers provide a company match. If the company match is 3% this means that if you deposit 3% of your gross income into your 401K account, the company will deposit an additional 3% for you. It's like free money, so make sure you take advantage of this by saving a percentage equal to at least the company match. Also, a simple savings strategy is to increase your contribution % every time you get a raise. This way you won’t even feel it.
The added beauty of the 401K is that your money grows tax deferred where you do not pay taxes until you withdraw it in retirement. This is most likely a time when your tax rate will be lower. In order to grow your money in the account, you will place your money in various funds. The choices vary from company to company but in general, funds consist of cash, bonds, and various stocks. Some may include target-date funds which are mutual funds with an asset mix that automatically become more conservative as you approach retirement age.
There are limits on how much you can contribute each year to your 401K. For reference, in 2014 the limit was $17,500 with an additional catch-up amount of $5,500 for those 50 years or older.
Another common strategy is to contribute to an IRA (individual retirement account). This too is a tax deferred account but is not linked to an employer and there is no match, hence the word “individual” in IRA. With the traditional IRA one usually has many more funds to choose from. You can contribute to your employer 401K and the IRA at the same time.
When investing, always remember to diversify, meaning choose a mix of stocks, bonds and cash appropriate for your age and years until retirement. If confused, it's always a good idea to consult a certified financial advisor. The government limits the amount you can contribute to an IRA. The 2014 limit was $5,500 with an extra $1,000 for those 50 years or older.
The Roth IRA was named after Senator William Roth of Delaware. It's an individual retirement account similar to the traditional IRA except that you are taxed upfront. This makes the money tax free when withdrawn in retirement. For reference, the 2014 contribution limits were $5,500 with an additional $1,000 for those 50 years or older. One small twist with the Roth IRA is that there are income limitations. If you are single and your adjusted gross income (AGI) is greater than or equal to $114,000 there is a reduced contribution amount. For couples the limit is greater than or equal to $181,000. See IRS Publication 590
The SEP-IRA is a simplified Employee Pension – Individual Retirement Account. This is used by business employers to provide a savings plan for themselves and their employees. The SEP-IRA follows all the rules for a traditional IRA. In this program, the employer, not the employee makes contributions to the account. The employer is allowed to contribute up to 25% of the employee's compensation and has the option to change the % each year. The contribution % must be the same for the employer and all his eligible employees. The contributions are tax deductible and earnings tax-deferred, making this an attractive option for business owners.
If you work at a tax exempt organization such as a school, hospital or church, you probably have the option to contribute to a 403b. It's a savings plan similar to a 401k where you contribute pre-tax dollars where it grows tax deferred.
Depending on your age, retirement may be decades away or just around the corner. Either way, you should not procrastinate and start today to save for your twilight years. Past generations could rely on what was called, “the three legged stool,” referring to the three main sources of income in retirement- social security, company pension and personal savings. Many companies also provided healthcare coverage in retirement.
That was then, this is now when individuals are ultimately responsible for their own retirement. Gone is the company pension and Social Security is not guaranteed. In fact, two of three projections of the Social Security Trustees estimate that unless changes are made, the Social Security trust fund will remain solvent for only another 20 years. So now more than ever, you need to take charge of your future and save for retirement.
Ideally, work life is rewarding, both financially and in terms of personal fulfillment. For workers on one end of the spectrum, doing what they love is the same thing as bringing home the bacon. Still others work primarily for the monetary rewards. Apart from each individual's level of job satisfaction, however, looking forward to retiring is a natural part of most workers' employment progression. In fact, as some workers age, it becomes the light at the end of the tunnel, which keeps them toiling.
The concept of retirement has traditionally been tied to reaching a particular age or station in life, allowing people to step out of customary work roles. For generations, the magic number stood at 65 – the age at which many employers and government agencies recognized the end of working years and awarded pensions and other benefits. As the cost of living continues to increase and social values shift among workers, the standard age has crept upward, keeping would-be retirees in the workplace longer than they once were.
Although Social Security benefit timing and other benchmarks have changed, requiring workers to stay employed longer, there is a simultaneous movement afoot among those wishing to leave the workforce before reaching traditional retirement age. The drive is influenced by personal goals and values, prompting many to entertain the prospect of an early exit.
Several schools of thought govern the ways people think about leaving the workforce. On one hand, some would-be retirees believe their golden years should be spent enjoying the “good life”, without pinching pennies. Planners committed to this philosophy are more likely to stay the course as long as possible, to generate substantial holdings before stepping away from work. Others measure quality of life using different standards, so accumulating vast fortunes for retirement is not a priority. To them, freedom means simply getting by, without sacrificing family and leisure time for affluence upon stepping down.
A blogger named Pete, who runs a site called Mr. Money Mustache, decidedly favors early retirement over other alternatives, having himself left the workforce while in his thirties. His blog shares insight about the process, which sometimes flies in the face of conventional wisdom. And while his posts are clearly shaped by personal values, various strategies espoused there provide food for thought.
And Pete isn't alone. Countless others have made moves toward early retirement, proving that it is not only possible, but feasible for many families. If it is on your mind, consider its two-pronged nature, in order to make it a reality.
The first question posed when considering early withdrawal often relates to the amount of money saved. How much of a nest egg is required, before bowing out becomes a realistic possibility? While certain standard calculations are used to identify a number, others factors influence projections. Spending habits, for instance, may have more impact on departure scenarios than income.
Investment advisors have been known to float an 80% income replacement ratio as the bare minimum needed for a comfortable retreat. In other words, keeping pace with expenses after retiring will call for 4/5 of your standard annual income earned while working. While the ratio provides a starting point for advanced planners, it is theoretical, and may not reflect your actual needs. According to one noted Wall Street Journal columnist, Jonathan Clements, there is a strong likelihood a cozy lifestyle might be maintained for far less. In fact, a 2014 survey conducted by T. Rowe Price showed content retirees living on an average of 66% of their pre-retirement incomes.
Those calculating post-employment needs must first recognize the inherent difficulty of the process. Projecting investment income and future spending is not an exact science, so despite the importance of planning, there are no guarantees outcomes will match predictions. Still, saving early in life is essential for amassing adequate funding, because it helps compound earnings, as gains themselves earn investment income. And since each person sets money aside at an individual pace, the exact proportion of personal income to be sequestered for retirees depends upon age and other factors.
Like the widely accepted 80% rule, prevailing wisdom recommends a minimum 10% savings rate during working years. Although the number might be a realistic goal for many, it sets the stage for decades of saving, before leaving the workforce becomes a probability. On the other hand, those able to save 30% of their incomes during prime earning years accelerate the process considerably, perhaps generating adequate resources for an early withdrawal from traditional employment roles.
Spending behavior works alongside savings, shaping available resources. Are you mindful of household cash flow, devising ways to trim unnecessary spending? Or do you cycle through monthly income without recognizing exactly where your money goes? The latter is an uphill battle toward departure from the workforce, because break-even budgeting does not adequately accommodate post-retirement income needs.
Too often, spending mirrors income, overtaking need, in favor of ill-advised purchases. As a result, disposable income disappears before it can be earmarked for retirement. And even worse, unsound spending practices continue beyond working years, depleting post-employment income faster than it can be replaced. To lay the groundwork for early retreat from employment and enjoy comfort beyond working years, prudent planners devise workable budgets and stick to their terms.
Household budgeting balances income and expenses, with a purpose. For those struggling to keep pace with daily spending, the function is simply to cover outstanding obligations. But with other objectives in mind – like retirement; accounting for personal finances takes on additional aspects.
Successful budgeting establishes spending categories, which break-down cash flow into manageable segments. The idea is to track money spent in each area, uncovering opportunities to trim spending, without compromising lifestyle. Typical categories include:
While an addition category accounting for savings is a good idea for anyone crafting a personal budget, those aiming for early withdrawal from gainful employment are well served by a classification earmarked exclusively for the purpose of setting-aside funds to make it happen.
Once classes are established to isolate spending habits, income and outgoing payments should be tracked for a minimum of three months. With 90 days' worth of returns to study, patterns become clearer – especially those leading to unnecessary spending. By rethinking personal cash flow and tightening their belts, those committed to leaving their jobs easily redirect money toward their priority.
There is a natural measure of uncertainty present for anyone forecasting return on investment. Statistical guides and past performance help refine the process, but without a crystal ball, few are able to identify precise, future proceeds from their investment portfolios. To hedge against lopsided exposure, prudent investors balance risk.
Maintaining diverse holdings leaves investors less vulnerable to downturns in particular segments of the world economy. Depending upon age and risk tolerance, typical investor portfolios should contain a mix of conservative holdings, like bond funds, as well as mutual funds furnishing broad market exposure.
One strategy favored by Mr. Money Mustache and other advocates of controlling your own employment destiny is called index investing. The long-term approach balances risk by reflecting as much of a total market index as possible – without requiring would-be retirees to purchase hundreds of individual stocks. The S&P 500, Nasdaq 100, and Wilshire 5000 are examples of indexes investors successfully ride toward early retirement.
Buying-in to index funds essentially furnishes a stake in each piece of the index – member companies that comprise it. Standard and Poor's S&P 500 index, for instance, represents 500 leading companies, which are chosen by market analysts to represent a broad picture of the overall market. By investing there, risk is spread across some of the biggest and best performers, so returns are less volatile than earnings gleaned from individual speculative stock selections.
Planning is at the heart of any successful saving and investment effort. Without a clearly defined mission, the probability of leaving the workforce prior to the standard age is left to chance. It may unfold as hoped, willed to materialize, but that is an unrealistic approach for those truly committed to the prospect. In order to stay on track, it is essential to maintain comprehensive awareness of where money is held and how investments perform.
Over the course of years employed, workers may change jobs several times, creating a number of different work-sponsored retirement plans. Issued by multiple employers, 401(k) accounts may even become hard to keep track of, as jobs change and life intervenes. There is legal protection in place to prohibit past employers from ditching reserves, but it is up to each investor to monitor various holdings.
The easiest way to stay on top of investments prior to leaving the workforce is to minimize the number of accounts held. In many cases, funds can be rolled into new accounts as jobs change, consolidating IRAs and other plans. To simplify the picture, at a glance, documents from each resource should be held together, separate from one another. Various apps and web-based resources are also available to help stay current on investment and savings performance.
Despite a lengthy tradition of personnel following standard retirement parameters, motivated individuals are capable of cutting working-years short – without suffering lifestyle consequences. Starting with a well-conceived plan and sticking to budgeting goals accelerates departure from the workforce, allowing would-be retirees to control their own destiny. By cutting non-essential spending and carving-out savings early in life, dreams become realities for those committed to early retirement.