Picturing yourself as a retiree may be hard if not impossible. But if you could envision those future years, you'd probably see a life full of activity and decades of health, happiness and prosperity. No rocking chairs and lap shawls need apply.
The reality, however, is probably somewhere in between. The problem with the picture is that the pleasure and comfort of your later years depend, to an ever-increasing degree, on the actions you take today.
So many changing facets of the American workplace have made it more important than ever to take control of your financial future. By investing now with a long-term focus, you can greatly improve your chances of having a fulfilling retirement.
Americans used to count on a pension plus Social Security to get them through those "golden years." These days, people change jobs more often, rely on dual incomes, and manage their own retirement funds through defined contribution plans. By most estimates, you'll need between 60% and 100% of your final working years' income to maintain your lifestyle after retiring.
|Sources of Retirement Income|
|This chart represents a breakdown of income sources for all retirees (aged 65 and over).|
|Source: Social Security Administration, 2012 (using 2010 data, most recent available).|
The accompanying pie chart shows the importance of saving now toward a retirement fund. Not only are Social Security benefits less significant, but the sums are diminishing and the age at which you can begin to receive benefits is higher. You can contact Social Security at 800-772-1213 to learn what you can expect in benefits, and when. Benefits are calculated on your earnings, with certain variable factors.
Alas, the responsibility for the bulk of your nest egg rests with you. Social Security represents approximately 37% of the aggregate income of Americans aged 65 and older, according to the Social Security Administration.
Also, as you begin thinking about how much you'll need for a comfortable retirement, you may be startled to learn the impact of inflation. At an average inflation rate of 3%, your cost of living would double every 24 years. Your annual income will need to increase each year even during retirement in order to keep up with the gradual rise in prices of everyday goods.
You'll also have to consider the likelihood of increased medical costs and health insurance as you grow older. The average nursing home stay, for instance, now costs more than $90,000 a year and could rise to over $150,000 per year by 2030, assuming an annual inflation rate of 3%.1
Now that you have an idea how much you'll need to finance your retirement years, of which there can easily be 25 or more, you may better understand the urgency to build your assets.
Financial experts estimate that most of us will need about 60% to 100% of our annual preretirement income to live on each year after we retire. Find out how close you are to meeting this goal by completing the exercise below.
|Table 1 - Factors*|
|Table 2 - Social Security Income|
|Years to Retirement|
|*Assumes 3% annual inflation and a 5% annual return.|
Traditional pensions (private and government) are estimated to supply about 18% of the aggregate income of today's retirees, while Social Security is estimated to supply 37%, although nearly two-thirds of retirees rely on Social Security for 50% or more of their income, according to the Social Security Administration (2011; using 2009 data, most recent available). Still, you'll probably fall far short of your goal. A radically reduced standard of living for a quarter century or more is hardly the stuff "golden age" dreams are made of.
Fortunately, you have some allies. First is the power of compounding, which takes advantage of time. Tax deferral is another ally. Using investment vehicles such as 401(k) plans or individual retirement accounts (IRAs), you can put off paying taxes on your earnings until you are retired and potentially in a lower tax bracket. Meanwhile, your contributions may be pretax or tax deductible, helping reduce current tax bills.
For example, an investment of $10,000 would grow to more than $100,000 after 30 years, at an annual return of 8%, if all the returns were reinvested and the account grew tax deferred. As with all hypotheticals, this example does not represent the performance of any specific investment and the earnings would be subject to taxation upon withdrawal at then-current rates and subject to penalties for early withdrawal.
The more time you have until retirement, the more fortunate you may be. Delaying just months -- never mind years -- can significantly reduce your results. Consider this example: Jane begins investing $100 a month in her employer-sponsored 401(k) plan when she's 25. Mark does the same -- beginning when he's 35. Assuming a 7.5% annual rate of return compounded monthly, when Mark retires at 65, he'll have $135,587. Jane will have $304,272.
While this is only a hypothetical and there are no guarantees any investment will provide the same results, you can see the remarkable difference starting early can potentially make. By starting early, investing systematically, and benefiting from the potential of compounding and tax deferral, you may pack a lot more punch into your portfolio.
Another advantage of today's retirement planning options is that you can control how your money is invested.
Investment plans need to be customized because different people have different degrees of risk they will accept as well as varying time frames they intend to hold their investments. Keep in mind, all investments involve risk including the possible loss of principal. A tailor-made portfolio can be diversified to take these factors into account. It's a wise idea to consult a professional financial advisor for complete information.
1Sources: MetLife Market Survey of Nursing Home and Assisted Living Costs, October 2011; Standard & Poor's, 2012.
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