Out With The Old, In With The New: Rethink Your Retirement Plan

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Throughout the month of December, The Simple Dollar is posting a daily series focusing on specific activities you can do right now to set the stage for a great 2011. Out with the old, in with the new.

8. Rethink your retirement plan.

If I’ve done one thing right with my personal finances since reaching adulthood, it’s been taking care of my retirement. I’ve consistently put a significant amount away for that future day when I no longer work and I’m ahead of the retirement curve for my age in almost every way you could measure it.

Having said that, of course, I’m in the huge minority there. Many people my age have scarcely thought about retirement. I regularly get emails from readers in their forties and even in their fifties that are just now beginning to think about retirement savings.

That’s a bad idea. Regardless of your age, the sooner you get started with retirement savings, the better. The more years you give yourself to save before retirement, the less you have to take out of each paycheck for retirement.

Getting a grip on your retirement plan really boils down to answering three questions.

Where are you at right now?
The first step is to understand what retirement savings you have built up right now and, to a lesser extent, what types of investments that money is held in.

Make a list of all of your financial accounts and their balances. This will, of course, require you to dig out all of those statements and log into your online accounts to retrieve this information (unless you’re using something like Quicken).

The purpose here is simply to get a grasp of the totality of your retirement savings. You need to know what you have before you can plan intelligently for the future.

Where do you need to be?
Once you have this information in front of you, you can use a retirement planning tool like this one at MSN to get an estimate of what you will actually need at retirement.

Personally, I find such software to be fairly good at giving you a starting point for your calculations, but almost every time, they tend to underestimate what you’ll actually need to do to get there.

Why? They tend to assume a very mundane rate of inflation while also assuming a more-than-healthy return on a diversified investment portfolio. If you know of a retirement portfolio that’s guaranteed to return even 7% over the next 30 years, I’d love to see it.

So why do I encourage people to use such software? First of all, you don’t have to use the default numbers they give you. Most people plug and chug with the default numbers at MSN, which suggests a 9% return on investment. Turn that down to at least 5%, if not lower.

Remember, it’s not a bad thing to save too much for retirement, but it is a very bad thing to not save enough for retirement. You can always retire a bit earlier or live a very robust retirement, but you don’t want to find yourself at age seventy or so without any ability to retire.

How do you get there?
So, how do you get from here to there? The retirement planning tool will give you a suggested amount for annual savings, and you should use that as a bare minimum.

Where do you save that amount, though? You’ll hear a lot of people tossing around suggestions of Roth IRAs and 401(k)s, but here’s the real truth: 99% of the worry about retirement savings is just simply doing the saving, regardless of where you put it. Compared to the concern of not banking nearly enough for retirement, the issue of having a Roth IRA or a 401(k) pales in comparison.

My rule of thumb for most wage earners is if you’re eligible, open a Roth IRA with some brokerage (I use Vanguard, but do your own research). This lets you be completely in control of the account. Also, money in a Roth IRA can be withdrawn at retirement age without any taxation at all, which is a nice perk, but the drawback is that you’ll be funding it with after-tax dollars – meaning the money comes directly from your paycheck. I usually recommend a Roth because I believe taxes will inevitably have to go up from where they’re at right now.

If you don’t know what to invest in among all of your choices, choose a “target retirement” fund that matches when you expect to retire. These investments will automatically balance your money for you, ensuring that you won’t be completely exposed to stocks close to retirement age (so that a big downturn like 2008 won’t sink you), but also gives you a great chance for growth now, when you’re young.

Regardless, the important thing is that you’re saving an appropriate amount. That’s the real key here. Today is the day to get started, if you haven’t already.

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13 thoughts on “Out With The Old, In With The New: Rethink Your Retirement Plan

  1. “it’s not a bad thing to save too much for retirement, but it is a very bad thing to not save enough for retirement”

    As long as you are not sacrificing the present for the future. It’s not all that black and white. Spend some money throughout your life to accomplish those things you want to do (that have a cost, like travel.) Don’t save it all for retirement, because, you know, we don’t all get there.

  2. One retirement expense that seems to be missing from a lot of calculations is health care expenses under Medicare – the ‘doughnut hole’ in the prescription drug plans, and a fairly significant Medicare Part B co-pay. This will be a significant added expense for us because right now we’ve got one of those “Cadillac” health plans but it ends when I retire.

  3. Retirement planning needs to cover health care costs. Fidelity Investments calculated that a 65 yr. old couple retiring in 2010 would need $250,000 to pay for medical expenses throughout retirement.

  4. I’m starting my Roth IRA in the beginning of the new year, and looking forward to contributing to my 401k at my year anniversary of being with the job. I plan on maxing out the IRA but how do I make up for the money I could be putting into a 401k? Should I open more than one account?

  5. I’m in major catch up mode. (Long story, sold a business, unemployed for 2 years yadda yadda.)
    I’m putting away 2000 per month in my 401k with 6% matching from my employer. As soon as I retire the remainder of our debt (from being unemployed 2 years!) I will be able to save 50% of our gross income. I cannot wait.
    Then I have inheritance from my mother, my husband and I have inheritance from his parents and he also has inheritances from one uncle and one aunt. BUT…I am very careful not to include those numbers in my planning because even though it’s probably 99% sure it’s still not a guarantee.
    My husband could leave me (doubtful but no guarantees right?) My mother could live to 120, haha
    Any number of things could happen (crash of 08 anyone?!)

    It’s nice to keep in the back of our mind (my husband is the executor and we’ve been given figures) but I don’t count on it. I like to plan for my own future and everything else is frosting.

  6. @Briana: You can’t get around the $5000 contribution limit by opening more than one Roth IRA – the contribution limit applies to all your IRAs, total, and there are some stiff penalties to pay if you break the rules. You just have to cool your heels until you’re eligible to contribute to your 401(k). Any savings you accumulate between now and then, you can put toward other goals (maybe build up your emergency fund) or put in a taxable investment account. You can count it as part of your retirement savings, but you won’t get the tax advantages of having it in an IRA or 401(k).

  7. My Hubby and I are among the many, unlucky, who will have no retirement. Unless a long lost uncle bigbucks dies suddenly, and leaves us a bundle. We are 48 and 50, still financing getting the kids out of the house, still fixing up on the fixer-upper home, and assisting elderly parents. We can barely get an emergency fund together, let alone money to put in a retirement fund. The kids already know this. We will work until we physically can’t anymore, and then they will be moving in with us, or we will be occupying that broom closet in the back of the kitchen at one of their places. Does that count as a retirement plan?

  8. There is some value in having a taxable income in the from a Traditional IRA or 401(k) – as our tax system stands now, the first $15,000 or so of income each year is “tax free” after the standard deduction, ect. We’re putting 1/3-1/2 of our retirement funds into a Traditional IRA to get a small tax deduction now and to diversify our income options at retirement.

    Trent, have you done any articles on the Saver’s Credit? I just realized that the credit is for the first $2,000 in retirement contributions per person, not per couple, and felt very silly that we weren’t contributing to my husband’s account. That’s a guaranteed 10% return for us on the first $4,000 in an IRA.

  9. @sewingirl (#7):

    Sounds like you’re in a tough spot, but you still have 15 years to correct things before you reach retirement age.

    You mention you’re still supporting kids. Are they 18? If so, then it’s time to let them stand on their own. If they’re in school, then they need to pay their own way, or even take on student loans. They can borrow money for school, but you cannot borrow money for retirement. You need to protect yourself FIRST.

    As for your own parents, are there any ways you can reduce how much it’s costing you? Maybe have them move in with you? Maybe they could even help you shave your own budget. If you’re currently paying a housekeeper, could your parents do the tidying instead, and save you the money?

    There are plenty of ways to free up a little cash and allow you and your husband to put aside a little more for retirement. However, I suspect, this is all falling on deaf ears, and I’m sure that for every suggestion I offer, you’ve got a dozen excuses that all seem perfectly valid to you.

    In the end, you simply need to be proactive. Nobody else is going to fix this for you. It’s up to you. Nobody cares about your future more than you do. You can make some hard decisions and fix it, or you can continue blaming external forces and being miserable and defeatist about it. It’s up to you, and to be honest, I don’t really care either way, because there’s a good chance that by tomorrow I’ll have forgotten all about you and I’ll never think of you again. I’ll continue being proactive in my own life, and you’re going to do whatever you’re going to do.

  10. While I put aside about 10% of my income for retirement, I am also in agreement with #1, Dishes and Laundry. I think it’s a good idea to find a mid-point between saving and enjoying life right now because there’s no guarantee of reaching retirement age.

  11. No question taxes are going to go up from here, but not necessarily in a way that makes a Roth IRA good for everyone.

    The trend in the last two decades and into the foreseeable future has been and is toward giving low to middle-income people various gimmicks by which to reduce their nominal (stated) tax rates, often to zero or (with the earned income credit) below.

    (Those people will indeed pay taxes, but they will be hidden taxes like inflation, lower investment returns, job insecurity, higher consumer regulatory costs and government user fees – things a Roth IRA will not protect them against.)

    Thus if you currently are paying taxes at anything over a 5% – 10T effective rate, but are likely to have a reduced or modest taxable income in retirement, you would be better off funding a Traditional IRA and taking the tax savings up front, with the reasonable prospect of being below the tax radar after retirement.

    I especially cringe at currently high-earning 20-somethings who are single, have no 401(k) options, no children, are renting so no home mortgage deductions, and are paying income taxes at a marginal 28% rate or higher, but funding a Roth IRA in preference to a Traditional IRA.

    Take the tax savings today. Forecasting both tax rates and your own personal income stream 40 years in the future is impossible. There will almost certainly be many future opportunities to convert, since conversions are a way for the feds to accelerate revenue. A person in the demographic I’ve described above will almost certainly have several future lean years, where the tax hit would be much smaller.

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