Photo: Flickr / Guanatos Gwyn
Pop quiz: Do you know how much money you need for retirement? If you’re like most people, you probably don’t.According to the Transamerica centre for Retirement Studies, most of us just guess how much we’ll need once we stop working. Only 1 in 10 people does any sort of calculation at all.
That might help explain why, on average, Americans are on track to replace less than 60 per cent of their income during retirement. Financial experts generally recommend that retirees replace at least 80 per cent, given the rising costs of healthcare.
The best way to unveil the big mystery is to punch some numbers. Luckily, online tools make it easy. Banks and brokerage firms increasingly offer calculators that can automatically incorporate your personalised information; Fidelity, T.D. Ameritrade, Transamerica, and T. Rowe Price are among those that do. If you prefer to do your own research, consider plugging your details into one of Bankrate.com’s retirement calculators. Be sure to experiment with different rates of return, inflation rates, tax rates, and lifetime expectancies, since no one can predict those factors with any accuracy.
Meanwhile, consider these six strategies for getting your 2012 retirement savings on track to provide fully funded golden years.
Save a higher percentage of your income all year long. The Employee Benefit Research Institute reports that on average, employees contribute just 7.5 per cent of their income to their retirement accounts. But most people need to save at least 15 per cent to be on track, according to Vanguard founder John Bogle. Instead of worrying, just save more, he urges. January is a good time to review your contribution rate and consider raising it for the year.
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Use the end of the year to bulk up your contributions. You can contribute up to $17,000 to your 401(k) in 2012; for those 50 or older, the limit is $22,500. If you’re nowhere close to that amount, consider ramping up your contributions to take advantage of tax-advantaged accounts. The same goes for Roth IRAs and traditional IRAs. If you want to max out your retirement savings, now is the time to start putting more money away. (You can contribute up to the 2012 limit until April 15, 2013.)
Consider opening an after-tax savings account, too. If you find yourself hitting up against the savings limit on your tax-shielded retirement account, consider opening an additional after-tax account that’s dedicated to your retirement. Just because the law prohibits you from putting more than $17,000 into your 401(k) doesn’t mean that’s all you should be saving—it’s just all you’ll be saving out of pre-tax money.
Use special savings accounts during work breaks. Just because you’re not earning a steady paycheck doesn’t mean you should put retirement savings on hold. Spousal IRAs for non-working spouses and Roth IRAs can make this easy. Roth IRAs are particularly useful for freelancers, students, and other people with unpredictable income streams, because you contribute money to the account after paying taxes on it, which means you can decide how much to contribute after considering your other expenses.
If you think your tax rate is lower now than it will be when you take the money out, you’ll benefit.
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Don’t forget about taxes. According to the Michigan Retirement Research centre, married college graduates—people who are otherwise among the most prepared for retirement—often forget to consider just how much of their retirement income will be going to Uncle Sam. Only 3 in 4 people in this group are prepared for retirement after taxes are taken into account; otherwise, 92 per cent report being ready. Many online calculators allow users to consider taxes in their calculations.
Lower your fees. Expenses can take a big chunk out of your investment return. But fees vary widely, typically from 0.1 to 2 per cent of your total investment on an annual basis. Think tank RAND calculates that even just 1 percentage-point difference in annual fees adds up to $3,380 after 10 years on a $20,000 account balance. But RAND found that when people were presented with various fund options, including one that clearly had the lowest fees, only half selected the lowest-fee fund.
One in 3 people inexplicably selected the fund with the highest fees. (All of the funds exhibited equivalent returns.) Index funds often offer lower fees, which means investors can keep more of their money.