Nowadays, the chance of having a pension from an employer are pretty small. And while seniors can expect to get Social Security benefits, those checks aren't nearly enough to live on without being supplemented by personal income.
It's entirely up to you to save enough for a financially secure retirement. Building up a big nest egg needs to be a lifelong goal and you need to know right now whether you're on track to hit your savings target. Take a look at the following three questions and if you can't comfortably answer them, you could be in serious trouble when you leave the workforce for good.
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1. How much should you be saving for retirement?
If you don't know what your goal is for retirement savings, it's impossible to ensure you're on track to meet it. So you need to decide what your target retirement savings number is. There are a few ways you can do this, including:
- Aim to save 10 times your final salary. This is the simplest approach, since it just involves estimating your final salary before retirement and multiplying by 10. But it may give you an imperfect answer since it doesn't take into account what you actually think your spending will be in retirement.
- Figure out how much income you'll need and work backward. You could estimate your projected retirement income by figuring you'll spend around 80% to 90% of your final salary once you've left the workforce. Or, you could actually try to figure out how much you think you'll spend in retirement (this is easier if you're closer to retirement). Once you know how much income you'll need, find out how big your investment account needs to be to produce it. Experts recommend withdrawing 4% of your retirement account balance in year one and adjusting upward annually for inflation. Figure out how much you'll need invested so 4% of it gives you your desired annual income. If you think you'll need $40,000, multiply $40,000 by 25 to see you need $1,000,000 in retirement savings.
- Use a retirement income calculator: Vanguard and other websites have online calculators to estimate how much income you need saved for retirement and how large your nest egg should be to produce your desired annual income in retirement.
Once you know what your end goal is for your retirement investments, use an online calculator to figure out how much to save each year to hit your goal. The amount you need to save to reach your target will depend on how young you are when you start. Remember: The younger you are when you begin saving, the less money you'll need to save each year to hit your goal.
2. Where is your retirement money invested?
Investing the right amount of money in your retirement accounts is important, but you also need to make sure you're investing in the right classes of investments, and in the proper proportions.
First and foremost, choose the right kind of tax-advantaged investment account you'll use to stow and grow your savings.
For most people, the optimal vehicle in which to store your retirement savings is a 401(k) plan or an Individual Retirement Account (IRA). Putting your money in these accounts gives you tax breaks, which make it easier to hit your savings goals. If you invested $15,000 in one of these tax-advantaged retirement accounts last year and you're in the 22% income tax bracket, you'd receive a $3,300 deduction in your taxable income for that year.
You also want the right mix of investment types within your retirement account. If you invest too conservatively, it will be next to impossible to hit your retirement goals; if you invest too aggressively, you run a big risk of losing money. If you invest $10,000 annually over 35 years and earn 7%, you'd end up with around $1.38 million, a pretty generous nest egg. But if you've been too conservative and earn just 4% in annual returns, you'd have only about $736,000, which is unlikely to provide enough money to retire well.
The right mix of investments depends upon your age and how much risk you can stomach. But in general, a good rule of thumb is to subtract your age from 110 and make that number the percentage of your portfolio that's invested stocks, and then put the rest in more stable investments like bonds. So, if you're 30, you'd have 80% of your portfolio in stocks; if you're 60, you'd have just half your portfolio in the market.
3. How much are you paying in fees?
Fees can significantly reduce the returns you earn, especially when you pay high fees over a long period of time.
Assume you made your $10,000 annual contributions over 35 working years and earned a 7% return on investment before fees. If you paid a fee of 1%, you'd end up with around $1.11 million -- not quite as good as paying no fee at all, but still plenty to live on. But if you paid 2% fees, you'd have just $903,000. And if your fees went up to 3%, you'd be left with just $736,000.
You don't want to lose hundreds of thousands of dollars to fees, so pay attention to the total you're paying. This includes administration fees charged on your 401(k), as well as expense fees charged by mutual funds or ETFs. Keeping fees as low as possible ensures your hard-earned money actually turns into a generous nest egg, rather than giving you barely enough to scrape by.
Make sure you're on track to retire comfortably
Now you know the three key questions you must answer to retire in style. Find out these answers today and, if necessary, make adjustments by upping your retirement savings, reallocating your investment mix, or looking for investments that charge lower fees.
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