In this episode of Money Girl, Laura covers various factors to consider for retirement planning, including a potential recession.
Find out exactly how much money you really need for retirement and by what age. Laura covers various factors to consider for retirement planning, including a potential recession.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Hi, everyone, and thanks for joining me this week! My name is Laura Adams, and I’m a personal finance expert and author who’s been hosting the Money Girl Podcast since 2008. My most recent title is Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. It was a No. 1 Amazon New Release and I just have to share a couple of verified reviews for the book:
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Today's episode is number 734, called How Much You Should Save for Retirement by Age (Even in a Recession).
I want to thank Adam, who inspired the show. He says, “Hi, Laura, can you talk about retiring during a recession or preparing for retirement while a recession is happening. Does it make sense to delay retirement for a few years or move somewhere with a lower cost of living if I’m behind on saving?”
Thank you, Adam! Saving for retirement is the granddaddy of financial goals because it requires a significant nest egg. And a recession can make it challenging to save enough if you lose your job or get lower-than-expected investment returns.
Knowing how much to save for retirement is more of an art than a science (even when the economy is stable) because there are many variables, which I'll cover. So, navigating through a recession can really rock your retirement boat.
But despite how confusing retirement planning may seem, I'll make it simple by giving you a guide for knowing how much money you'll need.
The whole point of saving for retirement is being able to enjoy a comfortable lifestyle after you stop earning an income. Most people reach an age when they're ready to slow down or cannot work due to poor physical or mental health.
Having a secure retirement means you have enough savings to preserve your pre-retirement income and standard of living. After you retire, you'll probably want to buy the same food, shop for similar clothes, and enjoy the same hobbies that you do now. You might downsize to a less expensive home or have lower transportation expenses, but other costs, such as medical bills and travel, could go up.
A typical retirement goal is saving 70% to 80% of your pre-retirement income. For instance, if you earn $100,000 on average in the years leading up to retirement, you might need a minimum of $70,000 to enjoy a similar lifestyle. However, the lower your income, the more difficult it may be to live on less in retirement.
However, you might want to plan for 90% or even 100% of your current income in retirement. That's my objective because I don't intend to reduce my standard of living. While I won't have to save more money for retirement, I'll likely have higher travel and medical expenses down the road.
If you have high aspirations for retirement, such as owning a second home, there's nothing wrong with planning for more than 100% of your pre-retirement income. Also, your future debt—such as a mortgage or student loans for a child's college—should be considered.
Let's cover typical sources for retirement income, and how much you need so you never run out of money!
In the United States, you're generally eligible for Social Security retirement benefits if you work for at least ten years. Social Security is a group of benefits for those who are retired, disabled, or survive a relative who received benefits.
The Social Security program gets funded from payroll taxes and self-employment taxes. If you're an employee, you may see the deduction listed on your paycheck as OASDI, which stands for old-age, survivors, and disability insurance.
As I mentioned, you must work a minimum of ten years to qualify for Social Security retirement. The calculation for how much benefit you receive gets based on the average of your highest 35 years of earnings. If you worked fewer than 35 years, the missing years get counted as $0 income, which brings down your average. And if you worked more, only your highest-earning years are considered.
The program taxes earnings up to an annual threshold, which has increased over time. For 2022, the Social Security tax for employees is 6.2% of earnings up to $147,000. Your employer pays an additional 6.2% on your behalf, adding up to a total annual tax of 12.4%.
If you're self-employed, you pay the full 12.4% into the Social Security system on your own by paying the self-employment tax up to the annual income threshold. While paying twice the tax on your self-employment earnings might seem unfair, remember that you can claim various business tax deductions that reduce your taxable income.
The Social Security retirement benefit you receive varies widely depending on your age when you begin taking it. The full retirement age gradually increased over time because we're living longer. If you were born between 1937 and 1959, your full retirement age is 66. But if you were born in 1960 or later, you must wait until age 67.
However, no matter when you were born, you can elect to take early retirement benefits starting at age 62. The problem is that you receive a permanently reduced rate, so it's not always the right decision.
Let's say you earned more than the annual Social Security threshold for most of your career. If you fully retired in 2022 at age 66, the maximum benefit would be $3,345 per month. But if you took early retirement, you'd only receive $2,364.
To increase your payout, you can delay retirement until age 70. If you took late retirement this year, the maximum benefit would be $4,194. That's about 25% more monthly income for the rest of your life, a simple way to secure a more comfortable retirement if you’re able to keep working.
The monthly benefits I mentioned would be the maximum amounts if you were a high earner your entire career. If you're a middle-class American who fully retired this year, you could expect a benefit in the neighborhood of $1,657 per month.
Remember that if you take time off from work, your benefit can go down, or if you get a raise or a second job, it can go up. Also, any earnings that don't have Social Security taxes withheld won't show up on your statement or get factored into your future benefits.
If you're worried that the future of Social Security is in jeopardy, don't be. While the reserve fund is drawing down, minor policy changes—such as increasing the payroll and self-employment tax or the annual income threshold—are all we'd need to raise revenue and keep the program healthy.
If you want to learn more about Social Security, go paperless, check your earnings history, and see your estimated future retirement income, create an online account at SSA.gov. Review your reported earnings for errors because mistakes could keep you from receiving the benefits you're entitled to.
While having some Social Security to rely on in retirement is great, it's not enough for most people. The program was designed to be a safety net for unprepared retirees, not a sole source of income. So, the bottom line is that you're responsible for creating your own retirement benefits.
Consider yourself fortunate if you're a rare employee with a workplace pension. A typical pension pays in the neighborhood of 2% of your income for every year worked. For example, if you stay with your company for 20 years, your future benefit might be 40% of your pre-retirement income. As you can imagine, offering a pension is very expensive for a company, which is why they've fallen out of favor.
While most workers don't have a pension, they typically have a workplace retirement plan, such as a 401(k) or a 403(b). Retirement plans cost companies less because workers bear the burden of funding them, not employers.
However, if you don't have a retirement plan at work or are self-employed, don't worry. You have options, such as an individual retirement account or IRA. Those with business income can fund a SEP-IRA or a solo 401(k), both of which allow you to save higher annual amounts than an IRA. Retirement accounts are the first place your savings should go because they come with money-saving tax benefits, making it easier to build your nest egg faster.
How much income you can or should take from your retirement savings depends on your:
I recommend investing at least 10% to 15% of your gross income for retirement. Doing that regularly for decades may sound boring, but it's the best way to accumulate a healthy balance to draw from in retirement.
While no one likes paying fees, they're unavoidable because brokerage firms that manage and administer retirement accounts have many expenses to cover. When choosing investments, pick those with the lowest fees, so they take as little of your earnings as possible.
Your investment return varies depending on the investments you choose. I recommend buying low-cost funds, such as stock index and balanced funds, because they're highly diversified, reducing risk.
If you're a young investor with a long time horizon, it's wise to purchase mostly stock funds that offer higher returns over the long term. As your time horizon gets shorter and you approach retirement, protect your account from potential losses by owning fewer stock funds and more income-producing investments, such as bonds.
Before I cover exact numbers on how much you need to retire, I want to explain why I said the planning process is more of an art than a science. Eight factors play a huge role in how much you need to save for retirement.
1. Your retirement age – is critical because the earlier you need income, the more you must save. Most people use the age they'll start receiving Social Security as a default. But if you accumulate a large nest egg, you can retire earlier.
2. How much you've already saved – plays a significant role in how big your nest egg will be at retirement. The sooner you begin saving, the more compounding interest works in your favor to grow your balance.
3. Your average pre-retirement investment return – determines how quickly your investments can grow. For example, investing $200 monthly for 40 years at a 3% return would grow to $185,000. But if you get an 8% return, you'd have $700,000. That's where those investment fees and your return on investment come into play.
4. Your post-retirement investment return – is also crucial because you must get a return from a portion of your savings while keeping it safe in low-risk investments once you're retired.
5. How much Social Security you'll receive – or other income, such as a pension, is critical for accurate retirement planning. Social Security may replace 30% of your pre-retirement income if you're a typical worker.
6. Inflation – causes prices to rise, making your retirement income less valuable. It's good to know that Social Security retirement benefits get adjusted for inflation as the cost of living rises; however, they could lag significantly.
7. Your withdrawal rate – is how much money you take out of your nest egg each year. Many people believe they can live on less than their pre-retirement income. However, if you dream of going on lavish trips, living in an expensive area, or end up needing costly medical care, you may require more income in retirement.
8. Your longevity - is the biggest unknown when it comes to planning for retirement. If you're relatively healthy at full retirement, statistics show you'll live well into your 80s. If you have a good family health history and take care of yourself, you could easily need retirement income into your 90s.
OK, taking all of that into account, how much do you need to retire? Well, most people need to accumulate at least ten times their average annual income to generate enough retirement income. For instance, if you earn $100,000, having at least $1 million is a wise goal.
Let's say you earn $75,000 and want to retire at age 67 with 80% of your pre-retirement income, or $60,000. You can probably count on getting about $20,000 a year from Social Security; the remaining $40,000 must come from savings.
Assuming you'll live 30 years and continue earning a conservative rate of return on your nest egg, getting income equal to 5% per year is reasonable. If you divide your annual desired income by this rate, that’s a total savings of $800,000 ($40,000 / .05 = $800,000).
As you can see, multiplying your pre-retirement income by ten, which comes to $750,000 ($75,000 x 10), gets you pretty close to the same number. But if you wanted 100% of your income (instead of 80%), you'd need about 14 times $75,000 in savings, or just over $1 million.
As your income, debt, and lifestyle change, reevaluate how much retirement income you'll need and whether you're saving enough to achieve it. While there are many unknowns, these basic calculations give you a target savings number to shoot for. You might have other assets, such as a paid-for home, or income from a part-time job or business, to help boost your retirement savings.
One way to make sure you're on track is to have a savings goal based on your age, such as a balance equal to:
If you're not on pace to have what you'll need, it's time to increase your savings rate!
Let's get back to Adam's question about retiring during a recession. If economic conditions create a financial hardship and you get behind on retirement savings, it's critical to catch up as soon as you're back on your feet.
If you work in an industry that could be hit hard by a potential downturn, consider investing 20% (or more) of your income instead of the 10% to 15% I mentioned. That way, you'll get ahead sooner rather than later.
You can make additional catch-up retirement contributions when you reach age 50. For 2022, workers over 50 can contribute an additional $6,500, for a total of $27,000. And if your company offers retirement matching, the overall contribution limit for those over 50 will increase to 100% of your compensation or $63,500, whichever is less.
And if you're getting close to retirement but haven't saved at least 80% of your goal, it's essential to continue earning an income and investing for as long as possible. However, as Adam mentioned, one option to retire on less is relocating to a less expensive city in the U.S. or abroad. Whether a move is temporary or permanent, it could be the ticket to finding more money to save, improving your lifestyle, and even having more fun in retirement.
If you’re not sure if you’re saving enough for retirement or are worried about a recession or getting a late start, speak with a certified financial planner or CFP. They can help you set the right financial goals, create a budget, and make your retirement dreams a reality.
Thanks again, Adam!
Before we go, I want to invite you to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
That's all for now. I'll talk to you next week. Until then, here’s to living a richer life.