As of 2013, the median net worth for a household led by someone age 60 to 64 was around $174,000. That might seem like a decent nest egg, but based on a typical rule of thumb for spending down your assets in retirement, it only represents around $7,000 per year in inflation-adjusted spendable income. When combined with the average Social Security benefit, the total works out to a total retirement income around $23,320 for a single person or $34,120 for a couple.
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That, in a nutshell, is why so many more people need to put money in IRAs. If that's the size of the nest egg they have built up by retirement age, that's the kind of lifestyle they can expect, plus or minus whatever happens to Social Security over the next couple of decades.
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What an IRA can mean to you
People under age 50 can potentially contribute up to $5,500 to their IRAs each year, and those age 50 or up typically can add another $1,000 more. Once invested, that money can compound, tax deferred, until you need to withdraw it in retirement. The combination of regularly putting money into an IRA, investing it to deliver a decent potential return, and letting it compound throughout your career can help you build a far larger nest egg.
The table below shows just how large your IRA can potentially grow throughout your career. It's based on an investment of $450 per month from the listed starting age until age 65, compounding at the listed rates. If you start early enough in your career and earn a decent enough rate of return, an IRA alone can propel you to millionaire status.
Table by the author
More importantly if you weren't an early saver, even mid-career professionals have a strong likelihood of winding up significantly better off than a typical current of near-retiree. And remember, these numbers are for a single person's IRA. If you're married, you and your spouse will likely each be able to contribute, potentially doubling these numbers.
But notice how the size of those potential nest eggs tapers off the longer you wait to get started. The most important thing you can do to boost the amount of money you'll have stashed away for retirement is to start investing early, then keep it up throughout your career. Even the highest return rate listed in that table is more or less in line with the stock market's long term historical annualized return rate. While there is no guarantee that the future will be as rosy as the past, time and compound growth still have the same effect, no matter what positive rate of return you earn.
How your IRA helps cover your retirement lifestyle
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Once you retire, you can begin drawing down your IRA to help cover your costs of living. At that point, you'll want to structure both the portfolio and your withdrawals in a way that gives you the strongest chance of seeing your money last as long as your retirement does.
Though there are no guarantees in the market, one strategy has emerged within financial planning circles as being both straightforward to implement and having a high likelihood of success. It's called the 4% Rule, and in a nutshell, it works like this:
- You start with a diversified portfolio across stocks and bonds;
- You maintain that diversification throughout your retirement;
- You withdraw 4% of the initial value of your portfolio in your first year of retirement, and
- You adjust your withdrawals based on inflation every year thereafter.
That gives you a great chance of having your money last as long as your retirement does -- even if it lasts three full decades. But that does mean that you're limiting your withdrawals to 4% of your portfolio's balance. So a $500,000 IRA becomes $20,000 a year in inflation-adjusted income, and a $1,000,000 IRA can generate $40,000.
No matter what IRA balance you wind up with when you retire, every dime you have socked away can help you live a better life than you could have on Social Security alone. That makes an IRA a great place for you to put money every year you earn a paycheck, and let it compound tax-free for your future.
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