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What Is Retirement?
Retirement refers to life after permanently leaving the workforce behind. People who have sources for financial support that they don’t earn by working can achieve retirement.
There are various reasons why one may decide to retire. One primary reason is because of age.
Retirement can happen at any time, but it usually occurs between the ages of 55 and 70. Some may plan to retire early, while others go with the U.S. standard retirement age of 65.
On the other hand, some are forced to retire due to an illness or disability.
But aside from these factors, financial stability also plays a role in one’s decision to leave work permanently.
While it is possible to retire without savings and solely relying on Social Security, it is not advisable. This is because Social Security benefits only cover 40% of the average worker’s earnings during retirement. It leads to a life of merely “getting by” post-work, and that doesn’t include emergencies and healthcare.
Unfortunately, statistics show that 1/3 of Americans age 55 and up don’t have a retirement nest.
Whatever the reason is, retirement is inevitable. That’s why you have to be ready when the time comes, and you have to leave the workforce. And by ready, we mean you should be able to enjoy a comfortable retirement without facing financial problems—that, or face the truth behind retirement.
The Truth Behind Retirement
- The average Americans retire at the age of 62, according to the U.S. Census Bureau.
- The average length of retirement in the U.S. is 18 years.
- Almost half of the surveyed retirees leave the workforce earlier than they intended. This is often done involuntarily.
- 14% of the surveyed retire to provide care for spouses or other family members.
- 41% of the surveyed retire due to health issues or disabilities.
- Around 10,000 baby boomers turn 65 every day according to a report by the Wall Street Journal.
- One-third of Americans age 55 and above don’t have a retirement fund, a 2018 study by the Government Accountability Office revealed.
- Americans believe they need $1.7 million to retire based on research from Schwab Retirement Plan Services.
- The savings of older households total an average of $59,500. That’s significantly far from the abovementioned $1.7 million retirement fund.
- Social Security pays retirees an average of $1,469.52 monthly. That’s an average of $17,634.24 annually.
- Pensioners have more significant income security. The average private pension is $9,376 annually. However, there are only 31% of retirees with pension plans.
Read here for more retirement-related statistics.
Despite most people dreaming of early retirement, several studies revealed that the majority of the U.S. population doesn’t save enough funds to leave their jobs.
The most common reasons why Americans fail to save up are:
- They don’t have enough money to save.
- They struggle to cover their bills, e.g., rent and mortgage.
- They prioritize paying off their debts.
A senior economic analyst from Bankrate called this case a “financial failure.”
According to TransAmerica, this problem can be rooted in the country’s lack of understanding of retirement. And this can further be rooted in the lack of education about the matter.
This lack of retirement nest egg forces the majority to work longer than they planned.
This is unfortunate, but this is the truth about retirement in the U.S. However, you can do something to avoid the same fate. Start by finding how much you actually need to retire.
Average Retirement Income vs. What You Need
When planning your retirement, the million-dollar question is, “how much do you need to retire?”
Many Americans believe they need $1.7 million to retire. This is based on research from Schwab Retirement Plan Services.
While the average retirement amount is an excellent place to start, you should still take into consideration several matters for a comfortable retirement. This means the amount still varies depending on your needs and wants.
Whether you want to live a retirement life similar to that of your standard pre-retirement living, or if you want a more luxurious lifestyle, you have to calculate the savings amount you’ll need.
Below are some steps to compute for your ideal retirement nest egg.
How Is Retirement Calculated?
3 Steps to Determine Retirement Income
Estimate Retirement Expenses
First, find out how much is your inevitable expenses. Get the sum of your housing, food, transportation, healthcare, and insurance expenses.
Then, add any discretionary expenses you have. These include travel, hobbies, and entertainment.
Get the total of your inevitable and discretionary expenses. This is applicable if you’re free of debts upon retirement.
Data from the Bureau of Labor Statistics show retirees from older households spend an average of $3,800 per month.
Read about the average retiree spending in the U.S., where you’ll discover the breakdown of expenses such as housing, transportation, and healthcare in a typical household.
Calculate How Much You Need to Retire
After getting your total monthly expenses, compute how much you need to retire. To do this, multiply your monthly expenses by 12.
$3,800 x 12 = $45,600
Then, apply the 4% rule of retirement.
4% Rule of Retirement
In this rule, you have to divide your estimated annual expense by 4%. For instance, let’s use the example above:
$45,600 / 4% = $1,140,000
Financial experts believe that the 4% rule is a safe amount when retiring. In fact, there is no historical case exhausting a 4% portfolio in less than 33 years, according to one study.
But this rule may not allow you to make major purchases in a single year, or you’ll have a difficult time in the later phases of retirement.
Alternatively, you can follow more general guidelines on building your retirement fund.
10% Rule of Retirement
$56,616 x 10% = $5,662
This rule is great if you start in your early 20s, and if you don’t know where to start building your retirement fund. By the time you reach retirement days, you’ll get a significant account to boost your nest egg.
80% Rule of Retirement
Experts also suggest the Rule of 80, wherein you save 80% of your annual pre-retirement salary. For instance, if you are making approximately $100,000 a year on average during most of your work life, multiply that by 80%.
$100,000 x 80% = $80,000
That’s how much you should save every year. This savings rule provides you with a standard of living post-work that is similar to the standard of living before you retire.
But the figures vary depending on how the lifestyle you envision during retirement. You may stick with the percentage or go lower based on your lifestyle preference.
If you want to learn more about calculating your nest egg, check out our average retirement income guide.
Work Towards Your Retirement Goal
After learning how to compute your retirement fund, it’s time to build your nest egg. There are several ways to do this. Below, we listed down some of the most common sources to save for your retirement fund.
Common Sources of Retirement Funds
Americans usually rely on the following sources of income in their post-work life.
Social Security is a government-run social insurance program. It serves as a protection against poverty, old age, and disability in the U.S.
You become eligible for Social Security retirement benefits if you have worked for at least ten years. This entitles you to a monthly pension from the Social Security Administration.
How much you will receive each month depends on the total number of credits you accumulate. This means that the longer you work, the more credits you earn. The maximum you can make is four credits per year.
While Social Security benefits are useful, these are not enough to sustain a comfortable retirement life. Social Security was designed to replace roughly just 40% of a person’s working salary.
Sadly, about 50% of retirees and 1/3 of the working population expect this insurance to be their primary source of income post-work.
The 401(k) plan is the most popular retirement savings in the U.S. It is offered to employees of most companies.
In this plan, you, the employee, invest a portion of your salary into long-term investments. Then, the employer offers a match to your contribution up to a limit.
The average 401(k) balance is $103,700, according to Fidelity Investments. Although account balances still depend on the generation.
Contributing to 401(k) also reduces the taxable income from your annual earnings. For instance, if you earn $50,000 and contribute $4,000, your taxable amount will only be $46,000.
The contributions are tax-deferred up until you retire. However, note that you will get penalized if you withdraw the funds early.
The individual retirement account (IRA) is another form of retirement savings. In this investment, you place your money in an account such as bonds, exchange-traded funds (ETFs), index funds, and stocks.
As an investment, the higher the risk, the higher the return you’ll get. The decision for your investments depends entirely on your hands.
Remember that there are different kinds of IRAS. For individual taxpayers, you invest in traditional and Roth IRAs.
The two IRAs differ from the way they are taxed. In the traditional IRA, you get taxed for your contribution and pay income tax. In Roth IRA, you can withdraw money tax-free.
Another type of retirement plan, pension plans require an employer to make a contribution to a pool of funds. This contribution is on behalf of the employees. That means the earnings of the investments go to you, the employee, as an income for retirement.
Some pension plans also allow you to contribute a voluntary amount. Your employer may match a portion of your annual contributions up to a specific amount.
Pension plan contributions also have a tax advantage. Just like in 401(k), the employer or the employee’s contributions are taken out of the taxable income.
When you retire, you can either choose a monthly annuity for the rest of your life or take out your money in a lump sum. Some pension plans allow for both—taking out some of the money in a lump sum and then use the remaining amount for periodic income.
In the past, pension plans were popular in the U.S. However, they have since lost popularity due to the current worker-retiree ratio. But they can still be found in some private companies and the public sector.
Investments like mutual funds, bonds, and real estate properties, among others, are also popular sources of income among retirees in the U.S.
These are a great way to save for retirement, especially when 401(k)s, IRAs, and pensions have annual investment limits. It’s an excellent place to grow your money once you maxed out the said tax-advantaged retirement plans’ annual limits.
Again, the higher the risk, the higher your return is. But you have to strategize your investments if your planning to make it a source of income for retirement.
Personal savings such as money market accounts, checking accounts, and savings accounts may also be a common source of income post-work, but it is not exactly the best way to get ready for retirement.
Although personal savings offer availability in case of emergency, long-term, they offer little to no interest. Over time, these forms of liquid assets get impacted by inflation.
Impact of Inflation on Retirement Fund
When planning your retirement, you should also take into consideration the impact of inflation.
Inflation happens when prices rise, while the value of a currency falls. It reduces the purchasing power of money, with an increase in prices of commodities occurring over time.
In simpler terms, inflation increases the cost of living.
Inflation is beyond our control, and most people do not focus on this economic occurrence. In general, they just save as large retirement amounts as they can to prepare for the impact of inflation.
But if you are interested in countering inflation, there are specific investments designed for this. It is called the Treasury Inflation-Protected Securities (TIPS), a form of U.S. Treasury bond.
TIPS have government backing, are indexed to inflation, and pay you a fixed interest rate. The latter is possible because the bond’s par value adapts with the inflation rate.
Retirement Readiness Checklist
Retirement readiness means having the ability to maintain the same standard of living as you did when you were in the workforce. This translates to having a retirement profit with at least 2/3 or 3/4 the amount of your pre-retirement income.
So, can you afford to retire? In the U.S., life expectancy is 79 years and up. That’s 17-18 years’ worth of retirement plan, considering the standard retirement age of 65. But sadly, most Americans do not have enough savings to last this long.
To avoid becoming part of this sad statistic, you have to be ready. Take control of your finances for the future with this retirement readiness checklist.
- Maximize your 401(k) contributions.
- Contribute to an IRA.
- Stick with a realistic budget.
- Learn to invest.
- Get rid of debt.
- Safeguard yourself and your assets with enough insurances.
Aside from your finances, you should also look out for your physical, emotional, psychological, and social well-being. Have goals and plans for life in retirement.
- Get and remain fit.
- Maintain a social circle.
- Continue to learn.
- Keep yourself busy.
- Live with purpose.
Are you preparing enough for your retirement? Learn more about our retirement readiness checklist and be financially, physically, emotionally, psychologically, and socially ready come retirement time.
Tips for Growing Your Retirement Savings
Sometimes, even with your Social Security, 401(k), IRA, and pension plans combined, your savings won’t just be enough. This is especially true if you want a more luxurious retirement life.
If you don’t want to depend on those traditional plans alone, there are some proactive approaches to earn more so you can sustain your needs once you leave the workforce.
Claim Social Security Later
On average, a retiree can get $1,474.44 per month from Social Security. But if you wait a little longer before filing a claim, you can enjoy an additional 8% benefits every year.
Typically, you could start claiming your benefits at the age of 62. But to get full advantage of Social Security, you should announce retirement past 66-68 years old.
Holding off your claim until your past your full retirement age entitles you with $3,790 per month. That’s more than double the average benefit.
Be Tax Savvy
Being wise about how you handle tax can save you a significant amount for retirement.
In a 2019 study about the long-term impact of taxes and other expenses on investment returns, the Schwab Center for Research found out that minimizing taxes has a significant effect.
This is because you lose the amount you pay in taxes. Also, you miss the opportunity to grow that money if it were still invested.
While it is impossible and illegal to avoid taxes, there are ways to reduce it. And that is through tax-efficient investing.
Tax-efficient investing is choosing the proper investments and accounts to put your money into. This includes tax-advantaged plans such as 401(k) and IRAs, as well as taxable accounts like a brokerage account.
Allocate your 401(k) properly pre- and post-retirement.
Allocating your 401(k) means deciding where your contribution goes. As a general rule, you should choose investments that meet your retirement goals while considering your risk tolerance.
There are various 401(k) allocation approaches you can take to invest without much effort.
- Use target-date funds. This fund is designed for individuals who plan to retire at a certain age. In this approach, you keep your portfolio diversified, spreading your 401(k) contribution across multiple asset classes such as stocks and bonds.
- Use balanced funds. This is great if you’re still not sure when you might retire. A balanced fund usually allocates your money 60% on stocks and 40% on bonds. This minimizes the risk of stocks as a balanced fund won’t rise or fall quickly when the stock market does.
- Use model portfolios. Alternatively, you can invest in a model portfolio crafted by skilled investment advisors. These portfolios follow a mathematically constructed asset allocation approach. They are usually divided based on their level of risk, usually named such as “Conservative,” “Moderate,” or “Aggressive Growth.”
- Spread equally across available options. Another way is to make a well-balanced portfolio. This means if there are ten available investment choices, you put 10% of your money on each option. However, this is not as fail-safe as the previous approaches because some options may not be suitable for your retirement goals.
How much you’ll benefit from 401(k) depends on your investment approach. That’s why you must know your options, and it’s best if you work with a financial advisor to help you make informed choices.
Diversify Investment Portfolio
The golden rule in investing is never to put all your resources into one account.
Relying on a single source of investment can put your savings at risk. This is why financial advisors always suggest diversifying your portfolio.
During your early work years, it is best to focus your resources on growth stocks. These are investments that increase in value over time.
When you’re nearing retirement years, it’s best to switch to interest-generating assets. These include dividend income funds, bonds, and real estate investment trusts.
Retirement life is entirely different from your life while you were still working. You are starting from scratch, but this time without a job to sustain your life.
Now, you depend on your retirement fund you have built over the years.
With no more regular monthly paychecks, how should you manage your expenses?
One way is to come up with an income strategy. Note all the sources of income you have, and from there, create a strategy. Have a monthly budget that is based on your expenses and life expectancy.
You may also consider investing if you have some savings.
The key here is to stick with your budget. Determine your needs and wants and assign a proper budget to each expenditure.
Pay Off Debts Before Retirement
Being under debt during your retirement years can make things go wrong for you. That’s why paying high-interest debts and mortgages must be your top priority when approaching retirement years.
Personal loans, credit cards, housing expenses—these can be a retiree’s worst nightmare.
So, when planning your retirement, you must include the cash sources from where you’ll pull the money to clear your debts.
Consider a Reverse Mortgage
A reverse mortgage is specially designed to cater to the needs of older Americans. This provides a stable income that requires less investment, which is excellent if you don’t have the necessary amount to sustain your remaining retirement years.
In a reverse mortgage, you make your home as the collateral. This gives you a significant amount of loan from a lender. The money you will receive will depend on the equity of your home.
But what happens to the reverse mortgage when you die? There are three options:
- Your legal heirs could settle the loan. Then, the lender will transfer ownership of the house to them.
- The lender could sell your house to the market. Any remaining balance will be paid to your legal heirs.
- You could deed your house back to the lender.
Learn more about why reverse mortgages are a powerful retirement tool as well as other vital information regarding this type of mortgage.
Following these financial moves allow you to save more than what you’ll get from your 401(k), IRA, and pension plan. It’s all about being wise about your finances if you want to reach your retirement nest egg goals.
Do You Have Enough for Retirement?
You may be excited and scared at the same time, thinking about your retirement. And you’re not alone. A lot of people are confused about where to start or how much they should be saving.
But the good thing is that there are guidelines out there to help you get on track.
To live a comfortable retirement, you have to find out how much budget you need to sustain a life without the monthly payslips. And the first step is to learn how to calculate your needed retirement fund.
Thankfully, there are easy-to-use online calculators to do the job.
Use our simple retirement calculator to determine how much you’ll need for a comfortable post-work life!
And with the tips above, you can start working on your nest egg with confidence.