Stop Thinking About Retirement

Last month a study by published by the Investment Company Institute revealed that IRA participation has steadily grown. The study found that IRAs now account for 25.4 percent of U.S. retirement wealth and at year-end 2008 IRA made up 8.5 percent of total U.S. household financial assets. This news illustrates a steady incline in IRA participation, but before we proponents of savings get all excited let me throw a negative at the statistics. Twenty-four percent means that just a quarter of our savings goes into a tax-advantage account. Only 8.5% of household wealth? We can do better and here’s how.

Stop thinking about retirement! The attitude that IRAs are for our golden years is the biggest deterrent to IRA participation. For most people in their 20’s paying this month’s rent and having some money for fun is a greater priority than saving for retirement. And for people in their 30’s supporting their family now is at the forefront of their financial plan. That’s why we don’t really start thinking about IRAs until we get older.

By age these are the stats:1
Ages 61-69—16% contribute to an IRA
Ages 51-60—10% contribute
Ages 31-40—participation is just 7%
Ages 21-30—a mere 3% contribute to an IRA

Saving for retirement is like preparing for death. No one wants to think about and we’ll do nearly anything to avoid it. So that’s what we do—avoid.

I propose that if you aren’t participating in a tax-advantage savings program (like an IRA) that you get a new attitude. Start thinking about wealth building. The maximum IRA contribution in 2009 is 5,000 dollars. That’s $5,000 tax-advantage dollars. The type of advantage depends on which IRA you choose. BTW you can still open and contribute to a 2009 IRA. The contribution amount can be limited by your Modified Adjusted Gross Income (affectionately known as MAGI). If you are over 50 years old, you get to add up to $6,000 to your IRA wealth building account.

I’m not going to bore you with the details on contributions and differences in the IRA plans during this posting. To find out more do the following, and start building your wealth and stop thinking about retirement…

• Call the Coors Credit Union and ask to talk with the Investment and Retirement Team. They’ll take a look at your situation and help you decide which wealth building tools will work best for you.
• Go to IRS.gov this site will give you the most accurate information and help you understand your choices. I know, I know it’s a government site, but there is a lot to be said for going to the source.
  
  1 Data released by Federal Retirement Thrift Investment Board, Analysis of 1997 Thrift Savings Plan Participant Demographics, December 1998; and Employee Benefit Research Institute, EBRI Databook on Employee Benefits, 4th ed., 1997.
  

Estimating Your Needs for the Future: 12 Times

Many have taken credit for the 12 Times Rule most often it’s been accredited to Jonathan Clements, former columnist for theWall Street Journal.

This formula assumes three things: 1) that your income will increase to match inflation, 2) you draw 5% of your savings as income the first few years of retirement, and 3) your return on ivestment is 5%.

The 12 Times Theory states that your wealth should equal 12 times your income. The amount you’ll need to set aside each month is dependent upon how long you have until retirement and your current savings-to-income ratio.

Using the 35 year-old that we’ve used before it might look like this:
$75,000 annual income X 12 = $900,000. But that’s not all…

This amount indicates 60% of your pre-retirement income. Combined with Social Security and other income, you might end up with 80%, a figure that most retirement calculators assume is enough. Alternatively, if your own calculations show that you need a higher percentage, then you need to amass more than 12 times your income.

It may seems like a crazy amount of money doesn’t it? But actually it’s not.

Yes, the ways you can look at determining future wealth needs are vastly different. In the end, however, though they may spit out amounts that vary slightly, they all seem to point in the range of $1 million. Pie in the sky? Possibly. But it’s not a bad thing to shoot for if you can make that your goal without getting too focused on the almighty dollar.

Estimating Your Needs for the Future: The 10% Beauty and Beast

We’ve all been told to start saving early and the 10% Rule proves this point. Save 10% of your income and invest it with long term returns around 10%, your portfolio will grow to the point that it can support your lifestyle from earnings in roughly 35-40 years. It doesn’t matter how long you live, you will not outlive your money if you follow this rule.

According to this rule we should all be wealthy and able to financially take care of ourselves well into old age, but that’s not real life. In real life we think that we can’t save either because we earn too little or have plenty of time for that later. Here’s the truth:

You might be young and earning very little, but then 10% of your income is small too. If you earn $22,000 and invest just $183/month ($2,196/year), you’ll be on track. But if you choose to wait until you are older you’ll need to invest much-much more to keep up.

Try it out by using this compound interest calculator.

In the above scenario a 25 year old earning $22,000 and investing $2,196 annually at a return of 10% would have over $1 million at age 65.

This is an easy it is to understand concept, it just seems that most people are reluctant to get started when they’re young.

Estimating Your Needs for the Future: The Millionair Next Door Formula

The following is the wealth building theory posed in the book Millionaire Next Door by Thomas Stanley and William Danko.

Your Age ˟ Your Gross Annual Household Income ÷ 10 = Your Net Worth Goal

This is a super quick way to estimate what your current net worth should be. It’s not an estimate for your future wealth goal. This rule does not consider inflation, taxes and varying interest rates. It does provide a useful estimate of your retirement savings goal. The formula is a good way to assess your current savings. Are you on track? or ahead? It can be eye opening.

So if you are 35 and earn $75,000/year your goal would be: 35 ˟ $75,000 ÷ 10 = $262,500

At 45 earning $75,000 your goal would be: 45 ˟ $75,000 ÷ 10 = $337,500

At 60 earning the same: 60 ˟ $75,000 ÷ 10 = $450,000

Liz Pulliam Weston of MSN Money had this to say about the Millionaire Next Door theory: “…this formula is problematic, at best. It requires substantial savings of people in their 20s and 30s, and it understates what people in their 60s will probably need.”

Note that the formula does not intend for you to include unexpected income from inheritance or other means. It should just be straight savings and investments. I have, however, known people who include the equity of their home in their personal net worth. In my opinion, it’s risky to consider your home equity as part of your net worth.

Estimating Your Needs for the Future: The Rule of 25

I’ve got a theory that you can’t get where you’re going if you don’t know where you want to go. Oh, I know someone else said that much more elegantly than I. This week I’m going to explore four common theories on setting your nest egg goals. Sure you can use calculators, but they can be complicated and cumbersome. The four methods I’ll cover simple yet great for setting tangible goals.

Today’s method: The Rule of 25

A simple explanation for the Rule of 25 is to add up your annual expenses, multiply by the number 25, and, voila, you get the amount you need for retirement. But it can be more complex than that. For one thing you’ll need to determine if your expenses today are comparable to what you’ll need in the future. If you are young and single you’ll probably need to increase the annual expenses a bit to compensate for your plans. Do you hope to have a family? pets? own a home?

Let’s look further at this theory. It’s just a mathematical simplification of the famous 4% rule where you expect to spend 4% of your savings during each year of retirement.

The rule assumes that you will be able to generate an annualized real return of at least 4% on your investments. A return of 4% return on a portfolio of $1.25 million yields $50,000. If you needed $40,000 to live on, you would need to save $1 million. If you needed $60,000, you would need to save $1.5 million. The amount you need to save to generate a specified annual income is always 25 times the annual income amount as long as you assume a 4% real return on your investments.

If your expectations for returns differ you can adjust the theory. Many people will downgrade the real return to 3% in which case you would then multiply by 33, instead of 25. Or multiply by 20 if you expect a 5% return. The more conservatively you approach the estimation, the more chances of success you will have, because you’ll sock away more savings.

Another way to apply the Rule of 25 is toward your current expenses and savings. If you take a look at an expense, say $4.00 each week for a latté which over one year would cost $208. Then multiply that expense by 25 you’ll find that for you’ll spend $5,200 during your lifetime on that treat. You might use this method to evaluate whether or not an expense is worthwhile.

So, the Rule of 25 is rather simple. It definitely gives you a goal to shoot for and I like that you can use it evaluate other savings and spending areas. Give it a try and then compare to some other theories that I'll cover this week.

How Much Money Will You Need in the Future?

Yesterday I asked I posed the question of retirement, whether you intend to or not. My point was that it doesn’t matter if you don’t “intend” to ever retire; life may make the decision for you. And if the decision is made that you must stop working, you’ll want to be prepared. So just how prepared or how much money will you need in the future? Sorry, no crystal balls here. One calculator told me that I would need $1.6 million another just around $800,000.

The guideline used to be that you could live on 70-80% of your highest salary. People used to count on a lower cost of living because the kids were gone, the house could be smaller, and work expenses like transportation and wardrobe were gone.

It also used to be that you could count on pensions and social security to cover a good chunk of expenses. And while we’re on the topic let’s not forget where social security came from in the first place. It was a depression era invention to encourage older workers to move out and make room for younger employees (a.k.a economic stimulus).

But times have changed. Like I pointed out yesterday people aren’t retiring as planned for a variety of reasons. So we shouldn’t think of 401(k)s, IRAs and stock investing just as “retirement plans”. Maybe a better term would be future wealth plans.

If there is one thing that you can count on for the future is that everything will be more expensive. So if you think about building your future wealth the first thing you’ll need to think about is your future. What do you want it to be like? Set your goals for future wealth on things that are tangible, not just arbitrary numbers that might make you comfortable.

Someone looking to generate $40,000 a year in retirement strictly from personal savings would need a nest egg somewhere between $500,000 (12.5 times the initial withdrawal) and $1 million (25 times the initial withdrawal).

A conservative rule of thumb suggests that if you withdraw only 4% -- or one twenty-fifth -- of your retirement nest egg during the first year and adjust subsequent annual withdrawals to compensate for inflation, you'll never outlive your money. Another approach is to estimate how much you'll need to withdraw from savings during your first year of retirement and multiply that amount by 25 to determine your target number.

So exactly how much do you need?
Two answers: 1) it depends and 2) probably more than you think.

I know I haven’t given a straight answer about how much you should be stuffing away, but all I really hope to impose on you is that even if you have no intention of retiring, you still need to build wealth for future needs.