After years of practice, I have come to some conclusions as how to bring more simplicity to the retirement planning process.
So often sophisticated confusion keeps people from taking even the most basic of steps. Unfortunately, far fewer options remain for a 55-year-old vs. somebody starting their planning at an earlier age.
Many individuals do not understand the basic step of starting to save early vs. later and do not take into account the impact of compound interest. For an individual starting at age 40, assuming a 6% return, they would need to save $1249/month to create $1,000,000 account balance at age 67. If that same individual wait until age 50, the monthly savings required is more than double or $2,800/month. Looking at a $70,000/year income, the percent of savings is 21% at age 40 vs 48% of pay at age 50.
The second issue is not knowing or projecting what the actual account balances would need to be to produce a desired income. Most planners use an 80% income figure as a percent of final pay. Using the example of $70,000/year, this would equate to $56,000/year of retirement income or $4,700/month. Before a savings balance is computed, other sources of income will need to be factored in to reduce necessary account balances to achieve the target income. Included here would be Social Security, pensions or income that could be produced from other saving such as IRAs.
Using again the desired income requirement of $4,700/month, if Social Security provided $2,200/month for you and your spouse, the income requirement is now reduced to $2,500/month. If there was, as an example, a $120,000 IRA, using a withdrawal assumption of 4.0% of the IRA account, the monthly income requirement is further reduced to $2,100/month. Other income or assets should also be factored in to reduce the necessary monthly income accordingly.
Assuming the above example of a $2,100 income deficit, assuming no other assets exists, the fund balance to create this amount at a 4.0% rate of distribution and a 25-year period of retirement (age 92 in this example), would require and an account balance of $630,000. This could be higher or lower based on inflation and the actual rate of return.
Finally, to achieve the necessary account balance requires a monthly savings based on the age that savings begin. If savings were started at age 40 and retirement was age 67, monthly savings at 6% would be $777/month or 13% of pay assuming the $70,000 income figure.
One a savings goal is determined; one should examine the best way to save. In all probability, a tax deferred account similar to an IRA, or additional deferrals to a 401(k), should first be considered. Pre- tax savings assuming an average combined state and federal tax rate of 20%, will only impact about $620.00 of monthly cash flow to save $777.00.
Other considerations:
Once savings goals are established, risk factors need to be addressed. What happens if you die before savings are realized? This would impact the income to your spouse or beneficiaries. What if there is a medical event that impacts the required savings or the ability to save in the future. Life insurance and extra savings reserves need to be considered.
Also, consideration should be given to post retirement income from part time employment. For example, if we assume a 4% rate of withdrawal from an account balance, every $20,000 of post retirement income saves the need to withdraw from a $500,000 account balance (4%x$500,000 =$20,000). This means the $500,000 could continue to grow with interest to a future date.
If savings goals cannot be accomplished due to time or ability to save in required amounts, goals need to be reduced or retirement should be delayed. A financial advisor can help you better determine where you are and can also suggest other means such as reversed mortgages and/or annuities that might be available. The key is to start planning today and not wait until your options are far more limited.