“We were told by our first financial advisor that we, with no children, will need $2 million to retire 'comfortably,' with the same standard of (middle class) living," says Moore. Moore and her husband had hoped to retire in 10 years, at age 60, but now realize they may need to wait if their retirement savings are insufficient, “particularly considering the age at which you can get Medicare and the likelihood that the 401(k) situation may change," she says.
Factoring in the future costs of health care, which are likely to increase—plus the possible need for long-term care (whether in a skilled nursing facility, assisted living or aging in place)—can be an eye-opener for many clients, says Debbie Heffernan Gallant, CFP, ChFC, RLP of Gallant Financial Planning in Rockville, Md.
1. How much do you need?
Some Americans put off retiring because they “don't know how they'll spend their time and what kind of resources they'll need," says Gallant. Others, unfortunately, may be forced to leave the workforce before they are ready, due to declining health or changing economic conditions.
It's never too early to start thinking about how you'll afford retirement.
A first step in developing any retirement plan is to think about what you want your life to look like once you've retired. What kind of lifestyle do you desire? Where will you live? What kinds of activities are you looking forward to?
Picturing your future life in retirement helps determine how similar or different your expenses will be from your current lifestyle. And that then determines how much money you'll need to retire, says Gallant.
2. How much do you have already?
The second step in developing a plan is to conduct a thorough financial inventory, says Gallant. What resources do you have to fund your retirement as of now?
Your list may include some or all of the following:
Social Security. If you or your spouse have been paying into the system during your career, you may qualify for benefits at age 62, although full benefits do not occur until 66 or 67 (depending on what year you were born). However, waiting until age 70 can increase your monthly check by as much as 25% or more.
Employer retirement plans. While the number of employers offering pensions that give retirees monthly checks for life has declined, many employers do offer tax-deductible ways to save for retirement. These defined contribution plans include 401(k)s, 403(b)s, SIMPLE IRAs or 457(b)s. These tax-deferred retirement accounts provided through your employer often include matching contributions, making them great ways to build up retirement savings while you're working.
IRA (Individual Retirement Account). Anyone with “earned income" from a job (or who is the spouse of a wage earner) can contribute to a tax-deductible traditional IRA or a tax-free Roth IRA.
Mutual funds. These investments form the core of 401(k) and other employer plans, IRAs and brokerage accounts. Instead of buying an individual stock, a mutual fund invests in a diversified portfolio of securities, such as stocks and bonds. Because a mutual fund includes a pool of different securities, it can help reduce the risk that the poor performance of a single investment will disproportionately harm your overall portfolio.
Cash savings. Savings outside of your retirement accounts can include money you have in bank checking and savings accounts, as well as certificates of deposit (CDs). These are your most liquid, or easily accessed, retirement assets.
Annuities. To create a steady stream of income in retirement, many people turn to annuities. There are various types of annuities, generally differentiated by when they start paying out — deferred or immediate — and whether their payouts are fixed or variable. “An annuity could help prevent you from running out of money," says Gallant.
Other investments. You may also have other vehicles that could help create retirement income, such as dividend-paying stocks, bonds and real estate.
Human capital. What skills or experience do you have that someone else will pay for? The more income you earn during retirement — whether through a freelance gig or part-time employment — the slower the speed at which you may have to spend down your other resources.
3. Putting the pieces together
Gallant likens creating a retirement plan to putting a jigsaw puzzle together. You dump all the pieces out — your existing resources — and start figuring out how to connect the pieces.
“Sometimes the picture you end up with doesn't match the picture on the box," says Gallant, meaning that the lifestyle you imagine and your existing resources don't mesh. You have to start thinking about how you can supplement or build up the resources you currently have available.
The approach to this puzzle, as with any retirement plan, is to consider the options that may be available to you:
- Social Security. When you begin taking Social Security can affect the size of your monthly payments. Research the benefits you are likely to be entitled to if you begin collecting at, say, age 67 vs. age 70.
- Personal savings. How much do you have in your employer plans, IRAs, investments and bank accounts? "Maxing out" your employer-sponsored plan contributions while you're working can be an important piece of the funding puzzle.
- Guaranteed income. Do you have access to guaranteed streams of income? An annuity is one example; an employer pension is another. Or you may choose to use the equity in your home to create a stream of income with a reverse mortgage.
- Human capital. Your ability to earn money through work, such as a side hustle or part-time job, or by leveraging other assets/resources, such as renting out a room in your home, may be something to consider as you develop your retirement plan.
Once you have reviewed your options, you can begin to fill in the missing pieces. This might include ramping up your monthly savings while you are still working, selling off inactive assets or shifting investments to help maximize income. There are a number of options and, the sooner you start, the more options you may have available to you.
“Don't wait until you've retired to think about these issues, because at that point you've closed some doors," Gallant says. For example, you may be able to make some extra IRA or 401(k) contributions before you leave work, to help maximize those benefits, she explains. However, once you've officially retired, some of those opportunities vanish.
The most important step, however, is the first one, according to Gallant. “Spending time thinking about what you want for your future and how you will fund it is going to help you come up with the best plan."