401(k) Tune-Up
Saving for retirement is one of those financial challenges that we know we have to do “someday” but the need for money in retirement seems so much less pressing than our need for money today. In the past, many people didn’t have to really worry about saving for retirement because their employer provided a pension. Today, almost no one gets a pension, except for certain government and military employees and large unionized workplaces. For the vast majority of Americans, retirement savings is our responsibility and for most of us, that means putting money aside in an employer-sponsored 401(k) plan.
When my husband began working his first full-time job after college, his workplace was full of ambitious young men who were always discussing strategies to increase their wealth. One of their “strategies” involved 401(k) savings. “Put in the max,” they told my husband. “You will reduce your taxes and starting young will mean that compounding will help you earn a huge amount of money by retirement.” We really had no idea what the 401(k) plan was but my husband heeded this advice and has always put in the max.
So, now a dozen years later, how are we doing on that 401(k) plan? In terms of actual dollars, we are just slightly better off than if we had stuffed the money in a mattress. When you take into account tax savings, however, we probably have done OK. We don’t feel we are on the road to riches with the 401(k) plan and have endured many years of wild swings in value in the 401(k) accounts. If we had been a little smarter investors, however, we might be doing quite a bit better than we are now.
Today’s post provides some tips and information about retirement planning to help you maximize your savings strategy.
How Much To Save
The first question in retirement saving is how much to save?
We know from our discussion of debt that most people are intimidated by very large numbers. If you want to feel intimidated, try a calculator for how much you need to save in retirement. One of the standard calculators is the Ballpark Estimate Worksheet from Choose To Save.org. They have tried to make saving for retirement “cool” with a series of humorous PSAs like the one below:
Every retirement planning calculator I have ever used asks you to input how much money you need at a minimum per year. If you don’t know, they generally estimate about 70% of what you are making now. For our fictional family, the Medians, how much would they need? Well, they should look to their budget.
Let’s assume the Medians are 35 years old now and plan to retire at age 70. At 70, they expect that their house will be paid in full, that they will not have any debt or loans and that they are not supporting any other children or grandchildren aside from themselves. If they were retired today, what might their budget look like?
ESTIMATED MONTHLY RETIREMENT EXPENSES
Housing Real Estate Taxes ($0.62 per $100 of assessed value on $200,000 home) $103.33 Home Insurance $24.75 Home Repairs/Improvements (1% of home’s value) $166.67 Subtotal Housing Cost $294.75 Food Groceries (assumes the “Moderate” cost of food at home) $522.10 Restaurant Meals $120.00 Subtotal Food Costs $642.10 Transportation Car Savings Fund (fund to purchase a new car when needed) $200.00 Car Insurance $166.67 Gasoline (assumes Mr. and Mrs. Median don’t drive all that often) $150.00 Vehicle Registration/Inspection Fees $7.00 Car Tax (required in Virginia) $50.00 Car Repairs/Maintenance $100.00 Subtotal Transportation Cost $673.67 Utilities Electricity/Gas/Water $200.00 Telephone/Cell phone $70.00 Internet $40.00 Subtotal Utilities Costs $310.00 Luxuries Clothes, shoes, haircuts, manicures, etc. $75.00 Gifts $50.00 Cable TV $60.00 Travel (cost of 1 or 2 big vacations per year, airfare, hotel, etc.) $125.00 Subtotal Luxuries $310.00 TOTAL ALL EXPENSES $2,230.52
Since both Mr. and Mrs. Median have been working, how much might they receive in Social Security benefits? According to the Social Security administration, the calculation of their monthly benefit is kind of complicated and depends on how much they earned each year they paid in to the system. The maximum benefit amount is $2,346 per month but the average benefit is $1,164. Out of that amount, you have to pay for Medicare insurance which costs $96.40 per month per person.
So, if the Medians earn the average amount of Social Security, they might expect to receive $1067.60 each after Medicare. Most likely, they will need to pay some additional amount for extra medical insurance but we will assume for this example that they don’t need to. If we factor in a small amount for taxes, they might each earn about $900 from Social Security each month.
The Median’s Social Security income after medical expenses is roughly $1,800. They need at least $500 a month ($6,000 per year) from their own savings to meet basic living expenses. So, how much do you need to save starting at age 35 if you need $500 a month in retirement until say age 100? You can use a calculator like this one to get an estimate.
There are a lot of variables in the calculation. If we assume the Medians investments do well at 8% per year both before and after retirement, the Medians need to save $76 a month. If the investments do modestly, say 4% before retirement and 1% after retirement, they need a total of $478 a month. Currently the Medians are saving about $182 a month in their employer retirement accounts. So, depending on how you interpret the calculations, the Medians are either just fine or need to save an additional $300 per month!
For anyone retiring after 2037, there is a good chance there won’t be enough money from the government to pay the entire Social Security amount. Most likely, people will get something, maybe 80% of the standard amount. This would make a big difference for the Medians. If they only get 80% of estimated Social Security, they need to come up with about $800 a month to meet basic expenses.
For those of us with enough time to retirement, we need to make sure we try as hard as we can to provide for our own retirement, regardless of what happens with Social Security. Even a small amount saved is better than nothing.
Rebalancing
While the biggest challenge for most people is simply having money to put aside for retirement, once you have an amount saved, you can’t afford to just let it sit there without a little attention. Most advisers suggest that you periodically rebalance your 401(k) portfolio. What this means is that you need to figure out what types of investments you currently have (stocks, bonds, cash, real estate, etc.) and what percent of your money is in each type of investment. You then need to figure out what the optimal investment mix is for your portfolio based on your age and risk tolerance. You then sell off investments that have done well and reinvest in investments that are lower priced to keep the investment mix “balanced.”
Confused? Here is another explanation:
Rebalancing is quite a complex concept and one of my goals for this year is to figure out how to do this for our portfolio. The biggest challenge I have faced is just figuring out what type of investments we have. Some of the mutual funds in our 401(k) plans are highly complex and it is really not clear at all what they are actually invested in.
Keeping an Eye on Fees
One other area we all have to look at is the fees charged by the various mutual funds in our 401(k) plans. There is a tradeoff in most mutual funds between the performance of the fund and the fees charged. Ideally, if the fund performs extraordinarily well, you might expect to pay a little more in fees for that fund. Often what happens though is that the fees charged by the fund are out of proportion to how the fund performs.
The video below explains how fees decimate your savings strategy.
There have been several articles recently advocating that investors look for “index funds” or other low-cost mutual funds. The Motley Fool even provides a letter you can send to your employer requesting lower-cost mutual fund options. You can see why this might be a good strategy for someone who doesn’t want to spend a lot of time evaluating the cost-benefit of various investment options.
Don’t Get Overwhelmed
If your head is swimming from all the above information, take heart. You don’t have to conquer all of this all at once. Start with a small goal to address just one aspect of your retirement planning. For 2010, you might just figure out how much you need to be saving (even if you can’t save it right now). If you are already saving, you might look at whether you need to increase your savings, rebalance or switch into mutual funds with lower fees.
It is somewhat amazing that all of this investing responsibility falls to average people, but that is the system we have and we need to learn to work within it. The good news is that if we can learn to become better investors, we might be able to do quite well with our retirement investing.
What lessons have you learned about retirement planning? Are you currently saving for retirement? Please share in the comments.