Planning For The Golden Years: Evaluating Retirement Savings Strategies

Saving for retirement is a daunting task for many people. While it's recommended that you save 15% of your pre-tax income each year, the amount you need to save depends on various factors, such as your current income, desired retirement age, and lifestyle choices.

Retirement savings guidelines suggest that by the time you're 30, you should have saved at least your annual salary. This should increase to three times your salary by 40, six times by 50, seven times by 55, eight times by 60, and ten times by 67.

However, these benchmarks may not be feasible for everyone, especially those who start saving later in life or have other financial commitments. The key is to start saving as early as possible and take advantage of tax-advantaged accounts like 401(k)s and IRAs.

Online calculators can help you estimate how much you need to save based on your income, contributions, budget, and retirement age. It's important to remember that these are estimates, and you should regularly review and adjust your savings plan as life changes.

How much should I be saving?

It is recommended that you save between 10% and 15% of your income each year for retirement. This is a general rule of thumb and the exact amount you should save will depend on your personal circumstances and retirement goals.

Rules of Thumb

The 80% rule states that you should aim to replace 80% of your pre-retirement income. This is a loose rule, with some suggesting 70% and others 90%. The 4% rule is another guideline that can be used to determine how much you will need to save to generate your desired annual retirement income. This rule assumes a 5% return on investments, no additional retirement income, and a lifestyle similar to the one you would be living pre-retirement.

Factors Affecting How Much You Save

• Life expectancy: The longer you expect to live, the more money you will need to save for retirement.
• Current spending and saving levels: If you are currently spending more than you save, you will need to save more for retirement.
• Lifestyle preferences in retirement: If you plan to maintain your current lifestyle in retirement, you will need to save more than if you plan to downsize.
• Age: The younger you are, the more time you have to save and the more your investments will grow.

How to Save for Retirement

• Start saving early: The earlier you start saving, the more time your investments have to grow and recover from any market downturns.
• Take advantage of tax-advantaged savings accounts: Contribute to traditional 401(k)s, IRAs, and health savings accounts (HSAs) to reduce your taxable income and grow your savings tax-free.
• Increase your savings rate gradually: If you cannot save 15% of your income right away, gradually increase your savings rate over time.
• Make catch-up contributions: If you are aged 50 or older, take advantage of catch-up contributions to your retirement savings plans.
• Diversify your investments: Ensure you have the right mix of stocks, bonds, and cash to meet your long-term goals, risk tolerance, and time horizon.
• Consider your investing style: If you don't want to manage your investments yourself, consider using a target-date fund or managed account.

Savings Benchmarks

While no estimate fits every situation, here are some general savings benchmarks based on your age:

• By age 35, aim to save one to one-and-a-half times your current salary.
• By age 50, aim to save three-and-a-half to six times your salary.
• By age 60, aim to save six to 11 times your salary.

How do I calculate my retirement expenses?

To calculate your retirement expenses, you should first determine when you want to retire. This is because the year you retire will have a significant impact on your expenses. For example, if you retire early, you may need a larger sum of money to cover your costs, and you will not receive the maximum Social Security benefits until a later age. On the other hand, if you retire later, you will have fewer years with lower income.

Next, you should consider your desired retirement lifestyle. Will you be travelling, taking up new hobbies, or spending more time with family? These choices will influence your expenses, so identifying your desired lifestyle will help you plan and save.

You should also consider the following expenses:

• Housing and relocation: You may choose to stay in your current home, downsize, or move to a different location. These options will have different financial implications, so it's important to factor this into your budget.
• Recreation: The cost of hobbies and activities can vary significantly. For example, curling up with a book is relatively inexpensive, while an amateur golf career will be more costly.
• Gifts for the family: You may want to help your family financially, such as by contributing to a down payment for a home or education costs.
• Taxes: You will likely still need to pay federal, state, and local income taxes, as well as property taxes if you own a home.
• Healthcare: This is one of the most significant expenses in retirement. It is difficult to estimate healthcare costs as health situations can change, but it is recommended that you allocate 15% of your income towards medical expenses.

To calculate your retirement expenses, start by listing your anticipated costs and tracking your expenses for a few months to ensure your estimates are accurate. This will help you create a realistic savings goal and ensure you have enough income to cover your expenses during retirement.

What is a safe withdrawal amount?

The safe withdrawal rate (SWR) is a way for retirees to calculate how much money they can withdraw from their accounts each year without running out of money. It is a conservative approach that aims to balance having enough to live comfortably without depleting retirement savings prematurely.

The 4% rule is a commonly cited guideline for safe withdrawals. It suggests that retirees can withdraw 4% of their retirement portfolio in the first year of retirement and adjust subsequent withdrawals for inflation to ensure funds last for 30 years. This rule assumes a portfolio with a balanced allocation of 50% equities and 50% fixed-income assets.

However, there are other, more dynamic ways to approach withdrawals. The guardrails or floor-to-ceiling approach, for example, involves setting an initial withdrawal rate and then adjusting it within certain boundaries based on portfolio performance. This strategy acknowledges the unpredictable nature of financial markets.

The safe withdrawal rate for an individual will depend on various factors, including:

• Time horizon: The shorter the time horizon, the higher the safe withdrawal rate can be.
• Asset allocation: Too high an equity allocation can expose you to sequence risk, which refers to how the timing of withdrawals could damage overall portfolio returns.
• Market returns: If the market outperforms projections, the withdrawal rate may be increased.
• Inflation: If inflation is higher than projected, the withdrawal rate may need to be increased to meet spending needs, but this may deplete the portfolio faster.

Which accounts should I withdraw from first?

When it comes to deciding which accounts to withdraw from first during retirement, a common strategy is to follow the order below:

• Cash: It is advisable to have an emergency fund equal to six months' worth of expenses. In the case of monthly expenses of $10,000 and a bank balance of $100,000, your first $40,000 of income should be withdrawn from cash or cash equivalents. This approach has two main benefits: growth and taxes. Cash will likely grow more slowly than other investment options over time, so by tapping into cash first, you allow your faster-growing and riskiest investments more time to grow. Additionally, drawing from cash will keep your taxes low in the early years of your retirement.
• Taxable accounts: Once you have withdrawn down to your emergency fund, you can start tapping into your taxable investments. These include individual, joint, and revocable trust accounts. Withdrawals from these accounts are likely to be taxed at more favourable long-term capital gains rates if held for more than a year. Additionally, since these accounts are not tax-deferred, they will grow more slowly than retirement accounts, making them a better option to withdraw from first.
• Tax-deferred accounts: This includes traditional IRAs, 401(k)s, 403(b)s, and SEP IRAs, among others. These accounts are tax-deferred, meaning you haven't paid income taxes on them yet, and will be taxed as income upon withdrawal. Therefore, it is often better to wait as long as possible before withdrawing from these accounts.
• Roth IRAs and Roth 401(k)s: These accounts are typically the last ones you should consider withdrawing from. Money in Roth IRAs and Roth 401(k)s is not considered taxable income when you withdraw from them, as long as certain conditions are met, such as being 59.5 years or older and having held the account for at least five years. Withdrawals are also tax-free for your heirs, making these accounts excellent tools for legacy planning.

It is important to note that the above sequence is a general guideline, and there may be exceptions or variations depending on your specific circumstances and goals. Consulting a qualified financial advisor can help you develop a customized plan that takes into account your unique situation.

How do I make my savings last?

It's important to make steady progress toward saving for retirement, no matter your age. Here are some tips to make your savings last:

• Withdraw only 3% to 5% from savings yearly, with adjustments for inflation. This is known as the sustainable withdrawal rate, which is the estimated percentage of savings you can withdraw each year without running out of money.
• Consider using guaranteed income sources like Social Security, pensions, or income annuities to cover essential day-to-day, must-have expenses in retirement, such as housing, food, and healthcare.
• Use withdrawals from savings for nice-to-have, more easily adjusted expenses.
• The longer your retirement lasts, the lower the sustainable withdrawal rate. For example, for a 35-year retirement, a withdrawal rate of 4.4% has worked 90% of the time, whereas for a 25-year retirement, a 5% withdrawal rate has been sustainable 90% of the time.
• The mix of investments you choose is key to how much you can withdraw without running out of money. Portfolios with more stocks have provided more growth over the long term but have also experienced bigger price swings.
• If you feel you need a high level of confidence that your savings will last throughout retirement, history suggests that a high allocation to stocks may not be the best option.
• If you have a more conservative mix of investments and a longer time frame until retirement, consider spending less.
• If you have a more aggressive mix of investments and a shorter time frame until retirement, you might be able to spend more.
• If you are willing and able to take less than your "allowed" amount some years, it will give you the flexibility to "overspend" in other years.
• If you are falling short of your savings goals, consider waiting a few more years to retire, or buying an annuity to cover your essential expenses.
• Start saving early. The earlier you start, the more time you have for your investments to grow and recover from any market downturns.
• Take advantage of tax-advantaged savings accounts like traditional 401(k)s and IRAs. Your contributions are made before tax, reducing your current taxable income and giving tax-free growth until you withdraw the money in retirement.
• If you have access to a 401(k), increase your automatic contributions as much as possible. At the very least, take advantage of your company's matching contributions if they are offered.
• If you are 50 or older, make the most of catch-up contributions to your retirement savings plans.
• Diversify your portfolio. Aim for a diversified mix of investments across asset classes, including stocks, bonds, and cash.

Frequently asked questions