A 5-Step Plan to Fill That Scary Retirement Income Gap

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Published May 16, 2012

| DailyFinance

The average American will face a 28% income shortfall in retirement, according to a recent survey by Fidelity Investments. And that's just the broad percentage: In dollars-and-cents terms, Gen Xers will be scrambling to find an extra $1,700 a month to cover living expenses, while baby boomers will fall a whopping $2,100 a month short of what they need to maintain their current standards of living.

That may sound like an insurmountable problem, but don't throw in the towel. As Fidelity's Kathy Murphy says, "finding the money to fill the income gap is not unattainable."

But if you want to do so, "take action now -- and the sooner the better."

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Here are five relatively easy steps you can take -- some as soon as today -- that will help prevent an income deficiency when you do retire.

1. Boost Your Stock Exposure.

If you're 40 or younger, adding a higher percentage of stocks to your portfolio with a lower allocation to bonds will allow your portfolio to grow more quickly than if you were in a "safer" allocation focused on a higher bond exposure.

Stocks have historically grown at roughly 10% a year, but even an allocation of 83% stocks and 17% bonds (as Fidelity hypothetically uses) could return 8.4% a year.

Unfortunately, if you're older than 40, a higher allocation to stocks is riskier and -- although it could help your portfolio grow more rapidly -- could have a detrimental effect on your investments if you retire during a bear market.

2. Save More. A Lot More.

Most Americans still don't participate in employer-sponsored retirement plans like 401(k)s. And this is a colossal mistake.

Many employers will match contributions, essentially putting free money into your account. Plus, a savings plan like a 401(k) is an easy way to force yourself to save. Money will come out of your paycheck before you can ever touch it.

For both baby boomers and younger workers, ratcheting up your contributions to an ideal 10% of your salary alongside a hypothetical employer match of 3% will have a huge, positive effect on your portfolio when you retire.


3. Wait a Little Bit Longer to Retire.

This tip may not be an easy one to accept, but it could have nearly as large an effect on your retirement income as boosting the amount you save.

First, working longer means a few more years of contributing to your 401(k) and a few more years of letting the contributions you've made over your career continue to grow. And this means you'll ultimately have more to withdraw when you eventually retire.

Second, it means you'll be able to delay relying on Social Security -- a move that could result in as much as a 76% higher payout.

The only caveat to this is that if you're in your 20s or 30s, you'll be retiring when the Social Security system is facing serious strain -- so you'll want to put more of an emphasis on working longer to save even more money.

4. Get an Annuity.

Annuities often get a bad rap -- and for good reason. Many are expensive, designed to rip you off rather than give you the assured stream of income you're after.

But although there are trade-offs that come with even the best annuity, the upside is that you have assurance that at least a portion of your money will safely be there for the remainder of your life.

You don't need to buy an annuity with all the money you've saved -- in Fidelity's example, annuitizing just 40% of the portfolio turned out to be a smart move.

This tip is especially helpful if your family has a history of celebrating 100th birthdays.

5. Receive Help from Your House.

The trick here isn't to apply for a reverse mortgage, or take out a home equity loan. But when you retire, chances are you won't need as large a house as you're used to.

By trading down to a smaller house (or even moving to a less expensive area), you'll have additional money you can put toward living expenses in retirement.

How Much Will These Tips Net You?

In Fidelity's hypothetical calculations, these five tips resulted in a Gen Xer with a $225-per-month surplus when he retired. And the baby boomer -- who began with a monthly shortfall of $2,100 -- was able to close that income gap substantially and end up with a shortfall of just $375.

Of course, there are even more useful methods to ensure a wealthy retirement -- many of which could close that gap even further. But whichever path you decide on, you will always have to be the one to take the first steps.

This article was written by Motley Fool analyst Adam J. Wiederman. Click here to read Adam's free report on how to ensure a wealthy retirement.

Related Articles From DailyFinance:

Point: Prepare for a Scary Income Gap in Retirement

Counterpoint: Why Generation X Shouldn't Panic About Retirement

Student Loan, Meet Social Security: Seniors Still Stuck with School Debt


 

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