If you’re behind on your retirement savings there is no need to worry; there are several things you can do to catch-up and still retire comfortably.
A lot of people are scared they will never be able to retire. The media does a great job of scaring the pants off people anytime a cloud shows up in the sky or a gust of wind more than 12 mph blows past the airport. It’s no different when it comes to money and retirement. The majority of people will be able to retire, it’s just a matter of when and how comfortably.
Check out some of the options available to you so you can enjoy your golden years.
What is retirement?
In 1881, Otto von Bismark, the Chancellor of Germany announced he was going to pay a pension to any nonworking German over the age of 65. It sounded like a great idea – especially since hardly anyone lived to age 65 in those days. He came up with this plan to counter the pressure from a rival political party at the time, and to provide a better life for the people in his country. Sounds familiar, right? Political promises?
Eight years later, Germany was the first country to introduce a retirement system which would provide for its citizens if they lived long enough. Up until that time, people worked until they died. Age 65 was selected based on the life expectancy of citizens, and it hasn’t changed until modern times.
Hitting 90 isn’t such a stretch with modern medicine. 150 years ago if the average age people died was age 90, it would be expected you would work until age 90 if you were physically able to do so.
I set that stage up, because when it comes to saving, a lot of people don’t even start thinking about retirement until they are in their 40’s. Maybe that explains why the saving rates are so small up until then. You get out of school, start a career, get busy working. Then you might get married, have kids, get a house. Those are all financially draining life events.
How much money will you need?
First, determine what your guaranteed income is going to be during retirement. Add up your tax-deferred accounts – 401ks, 403b, 457s, social security, pensions, annuities.
Then you need to figure out what your estimated expenses are going to be each year during retirement, as well as any big ticket items you plan on purchasing. Most likely at some point during retirement you’ll need a new vehicle, you might go on several vacations, health care costs, etc. And it is a best guess.
Which is why it’s a good idea to learn how to budget or, at least, track your spending, so you know what that number is.
The difference between what your retirement income and your retirement expenses are is the gap you have to make up, or ‘catch-up’.
Once you know the difference, you can start making adjustments to your current spending patterns, increasing your income, or plan on working longer. The simplest way to catch up is to put aside as much as you can from every paycheck into retirement accounts. Once you know the gap between what you have and what you need, you have a target to aim for.
Fidelity has guidelines for individuals look like this:
- By age 35, save one times your gross annual salary
- By 40, save two times your gross annual salary
- By 45, save three times your gross annual salary
- By 50, save four times your gross annual salary
- By 55, save five times your gross annual salary
- By 60, save six times your gross annual salary
- By 67, save eight times your gross annual salary
Note these are back-of-the-envelope guidelines. You would never bet your retirement on such a simple formula.
How to cover the gap
If you find you have a gap between what you have saved and what you think you’ll need, there are several options you can look at.
One option is just to work longer. This gets back to that arbitrary retirement number of 65 – it’s just a number.
What are the pros and cons of working longer?
One advantage is you don’t tap into your retirement accounts as early, giving them more time to grow. Allowing investment accounts to grow an extra five years, for example, can have huge impacts.
On top of that, you continue to save more. In addition to not touching what you have already saved, the longer you work, the more you get to sock away for later. It’s an excellent one-two punch. You reduce the stress you feel internally because the more you put away, the better you’re going to feel about retiring and not worrying about running out of money. But you also reduce the stress on your investments, because they go untouched for that much longer.
Also, your social security retirement benefits are increased by a certain percentage if you delay your retirement beyond full retirement age. The exact increase depends on your date of birth, but it can range from 5.5% up to 8% per year.
Disadvantages of working longer
The big unknown is if you’re not age 65, how do you know if you’ll be able to work when you are 65 or older? Will your job still be there? It’s going to be a lot harder to find a comparable job making the same income if you lost your job in your 60’s.
Will you need to take care of a sick spouse? If you become a caretaker, working is going to become much more challenging.
Will you be physically able to work? You might have a bum knee or bad back making it difficult to withstand the rigors of working 40 hours a week depending on your job requirements.
What if you change your mind? Finally, you might think you will work into your retirement age and then later decide to do something else. The intention might be there, but the desire may go away.
When should you take social security?
If you don’t have to touch your social security benefits at age 62, you should let them be. Each year you defer collecting, your benefits compound up until age 70. At age 70 – depending on your age now – you could be collecting 132% of the benefits than if you started at age 62. It’s a significant upside.
But to do that, you have to either be willing to work until age 70 and live off your earnings, or tap your investments starting when you leave your job. If you start drawing down your investments in a down market, it’s going to eat up your savings faster. There are trade-offs you need to consider.
What if you take social security early and invest it?
Some people say you should take social security as early as you can and invest it. The goal is you’re trying to do better than the return you get by not withdrawing on your benefits.
It sounds reasonable, but the unknown is can you find an investment that is guaranteed to outpace the guaranteed return of what you would get by not withdrawing the money?
For example, if you are a baby boomer born in 1960, social security gives you a guaranteed rate of return of 8% per year if you leave your money in until age 70. How many investments do you know that guarantee an 8% rate of return for three years straight?
The disadvantage of not taking social security earlier is if you wait to start withdrawing, and you die before age 70, that money you worked all your life for and the government took from you is gone. You can’t leave it for your children for example, like you could if you started pulling it out at age 62 and gifting it to them.
Catch-up retirement savings
What if you’re aged 50 or older and find you’ve fallen behind in your retirement savings? There are several opportunities to save more of your income in tax-deferred accounts through catch-up provisions.
If you have a 401(k), 403(b), 457 plan, or Thrift Savings Plan the 2016 limit is $18,000 that you can contribute. If you’re 50 or older, you can contribute an additional $6,000. Those limits are the employee limits, not what you’re employer puts in.
With an employer match, you can end up exceeding the employee limits. The total combined limit for employer and employee contributions is $53,000 ($59,000 for participants age 50+).
97% of all 401k plans have a catch-up provision.
If you find your employer’s plan doesn’t have this provision, you can lobby the employer to amend the plan. According to the Plan Sponsor Council of America, only 36% of plans allowing catch-up contributions will give you a match for your catch-up. Still, it’s a great way to save so take advantage of it.
What if your employer doesn’t offer any retirement plan?
Millions of people are in this situation. If that’s you, your first step is to get started with a Roth IRA. You can get one setup in less than ten minutes.
IRA contribution limits
The traditional IRA and Roth IRA contribution limits for 2016 is $5,500 (total contributions to all of your traditional and Roth IRAs).
The limit is $6,500 if you’re age 50 or older.
What if I’m self-employed?
If you are self-employed the other alternative is to open up a Simplified Employee Pension (SEP) or Solo 401(k). The paperwork to open either is pretty simple and straightforward. You can open up a SEP or Solo 401(k) at low-cost brokers at no cost.
SEPs and Solo 401(k)s are like a traditional IRAs and employee sponsored 401(k) plans in that the money you put in will reduce your current year’s taxes. You’ll pay the taxes when you start pulling out the funds in retirement.
The total contributions can be up to $53,000 per year ($59,000 if you’re playing catch-up).
If you don’t want to start saving money now, or you can’t start saving money now because of your current situation, it’s not the end of the world. If you’re in your 40’s or 50’s, you’ve got a long time to go.
How should you allocate your contributions if you’re playing ‘catch-up’?
If you’re not in a target date fund, when you’re trying to figure out what to invest in within your Roth, 401k, etc., you want to consider your risk tolerance and your time horizon. There are some things you want to look at:
- Asset allocation. How you’re dividing your investments – should match your timeframe. If you’re ten or more years out, you would be a little more aggressive and in higher risk investments – more stocks, fewer bonds. Stocks have higher risk, but they have the potential to grow your money more. As you get closer to your retirement date, your investments should be allocated more conservatively – more cash and bonds, less in stocks.
- Consider your life expectancy. If you decide to retire at age 65, that doesn’t mean you cash out everything and put it in a bank account. If you think you might live another 20 years until age 85, you still want your money to at least keep pace with inflation. Again, that means proper asset allocation and risk.
- Stick to your plan. Somewhere in those 10–30 years, the stock market is going to go up and down. Sometimes by a lot. The people who jump in and out end up the big losers. If you’ve done your research and believed in the plan and course you’ve set, stay the course. Even during the rough patches.
Potential issues with this investing strategy
It’s a good strategy to put as much as you can into tax-sheltered and tax-deferred investments. What you will run up against is this strategy by itself usually isn’t enough to cover a shortfall.
Compound interest is your friend when it can work for decades. Someone in their 50’s just doesn’t have the time money needs to grow to have a massive nest egg, which is why you’ll need to look at other avenues to make up the gap.
Should you take on more risk when investing?
If you haven’t saved as much as you wanted to, you might be tempted to throw caution to the wind and invest less in bonds and cash and go heavily into an investment strategy that is more heavily weighted towards stocks, and riskier.
It’s not unreasonable to take on more risk if you have a strategy that covers you if the market has a big slide downward just as your ready to start pulling money out. But time is not on your side because you don’t have as long to recover from big market dips if you are heavily invested in stocks.
If you were heavily invested in stocks in 2008–2009 when the market lost 50% of it’s value, you wouldn’t have the time to recoup your losses if you needed to pull money out of your portfolio as the market slid down.
The smart play is to have the money you’re going to need in the short term already carved out in more conservative investments. Then if and when you do need the money, even if the market is down you’re not withdrawing from funds that have been hit with recent losses.
If you are already maxing out your investments or doing the best you can to do so, there are some other areas of your life that you might take a look at to help you retire when you want to.
Will you need to cut back?
If you’re frugal now, the chances are that will continue into retirement. It’s unlikely you’re going to switch from eating cereal for breakfast to suddenly going for steak and eggs 7-days a week.
Many people thinking about retirement are looking forward to simplifying their lives – getting rid of unwanted stuff and downsizing.
Another place to look for retirements savings is your lifestyle, and the sooner, the better. Consider getting a smaller house now rather than waiting. Then pocket those savings that would have gone towards a mortgage, utilities, and upkeep.
What if you live paycheck-to-paycheck?
There is more room to trim expenses if you have a higher income. For lower income families and individuals as you hit retirement, there may not be an opportunity to trim expenses. If you have a tight budget now, chances are you will need a bigger nest egg to replace your income in retirement. It will be more of a challenge to cut the estimated 20% of your expenses used as a general guideline once you retire.
What about healthcare?
You can’t know if you’ll be running marathons or be wheel-chair bound in your golden years. That’s the problem we all face – it’s a guessing game. Your best-laid plans may get derailed because of health care costs. These costs can easily chew up huge chunks of your retirement savings.
Now that you know 150 years ago you would have never even thought about sitting on your front porch 7-days a week sipping lemonade starting on your 65th birthday, maybe you’ll be less concerned about dwelling on an arbitrary number like 65. You can work until you can’t physically work anymore, or you can enjoy sipping lemonade with the grandkids. You get to choose.