For many people, starting to save for retirement falls low on the list of financial priorities. Because you have a mortgage, a family, or just want to enjoy life, retirement savings can easily be overlooked. It doesn’t help that retirement seems so far away. “I’ll have plenty of time to save later,” you might hear yourself saying. But time flies and, before you know it, you’ll be ready to hang it up and spend the rest of your days on the beach. However, this won’t happen if you don’t plan your retirement carefully.
Often, we assume that social security is waiting for us at retirement like a pot of gold at the end of the employment rainbow. But this misrepresents the nature of social security, which was intended to supplement our retirement costs, not fully take care of them.
It’s not realistic to expect to live off of social security benefits, but too many people discover this too late. For example, a 30 year-old making $50,000 per year can expect to take in less than $22,000 per year from social security. According to the Social Security Administration, benefit payments make up an average of 38% of American’s income. That means that the remaining 64% comes from additional investments, such as retirement accounts, rental income and other investments.
We’re not trying to scare you, but we would rather get you prepared for the challenges of the future by heading them off. After all, the more you know, the more you’ll know how to handle it.
When should I begin saving?
You might be tempted to delay thinking about how to save for retirement until you’re making more money, but it’s best to start young for several reasons. While it’s never too late to start saving for retirement, you’ll have to save a larger share of your pay if you’re playing catch-up in your forties.
You tend to have less expenses in your early 20s, especially if you haven’t yet started a family and don’t have a mortgage. This leaves you extra money to stash away. Also, the magic of compound interest makes investing during your younger years a smart choice. For example, a 25 year-old investing $75 per month into a retirement account will have more money upon retirement than a 35 year-old who invests $100 per month. Compounding means that you can invest less, but earn more, as long as you start early. So, start now!
How much should I save?
The size of your retirement nest egg largely depends on the type of lifestyle you envision for your golden years. Do you plan to be a hermit and read philosophy texts all day? If that’s the case, you’ll need less than someone looking to travel around the world or taking up baccarat as a hobby.
According to Vanguard, a healthy savings target is 12-15% of your income per year. If this sounds too ambitious, then you can set periodic goals to build up your savings stamina. Start by allocating 5 or 10% of your paycheck each month to your retirement account. Then each year, increase your savings rate by 1% until you hit your 15% goal. After you’ve established a routine, you won’t even miss the money. You’ll also be pleasantly surprised once retirement closes in.
Developing a budget
Assembling a budget provides you with a more realistic view about how much you’ll need and how much you can spend. On average, plan to retire for about 30 years, or longer if you plan to retire early. Health issues and other complications may force you to retire early, so it’s nice to have a cushion just in case.
To find out what you’ll withdraw each year from your retirement account, you’ll need to factor in all other income at the time of your retirement. This includes social security payments, pensions, rental and other investment income.
Once you’ve added up all your income, you’ll need to subtract this from your spending. It’s difficult to gauge what, and how much, you’ll spend in the future because your interests and life circumstances change over time. But one rule of thumb states that you should plan to spend 75-85% of your current income.
The lower amount of spending assumes that you’ll have less expenses upon retirement, which is usually true but not necessarily. This is based on you spending less on:
- Payroll taxes
- Debt (assuming it’s paid off)
- Retirement savings
- Expenses related to work, such as gas and dress clothes
However, you’ll need to consider how you want to spend your twilight years. Your expenses rise if you hope to travel, buy a second home, a boat, a private island or any other kind of luxury. This may shoot your expenses back up to 100% of your current income or even higher.
Hopefully, you can see why it’s helpful to start thinking about how to save for retirement while you’re young. But putting together a budget is the only way to know how much you’ll need for sure, so let’s get into it.
Read on to get step-by-step instructions on developing a budget.
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