Retirement Planning: The Basics
Y
By John McRae
Contributing Columnist
ou may have a very idealistic vision of
retirement — doing all of the things that you
never seem to have time to do now. But how
do you pursue that vision?
Social Security may be around when you retire, but
the benefit that you get from Uncle Sam may not pro-
vide enough income for your
retirement years. To make
matters worse, few employers
today offer a traditional com-
pany pension plan that guar-
antees you a specific income
at retirement. On top of that,
people are living longer and
must find ways to fund those
additional years of retirement.
Such eye-opening facts mean
that today, sound retirement
planning is critical.
But there’s good news:
Retirement planning is easier
than it used to be, thanks to
the many tools and resources
McRae
available. Here are some basic
steps to get you started.
Determine your retirement
income needs
It’s common to discuss
desired annual retirement
income as a percentage
of your current income.
Depending on whom
you’re talking to, that
percentage could be any-
where from 60-90 percent,
or even more. The appeal of
this approach lies in its sim-
plicity. The problem, however, is
that it doesn’t account for your spe-
cific situation. To determine your specific
needs, you may want to estimate your annual retire-
ment expenses.
Use your current expenses as a starting point, but
note that your expenses may change dramatically by
the time you retire. If you’re nearing retirement, the
gap between your current expenses and your retire-
ment expenses may be small. If retirement is many
years away, the gap may be significant, and project-
ing your future expenses may be more difficult.
Remember to take inflation into account. The aver-
age annual rate of inflation over the past 20 years has
been approximately 2 percent. (1) And keep in mind
that your annual expenses may fluctuate throughout
retirement. For instance, if you own a home and are
paying a mortgage, your expenses will drop if the
40•
mortgage is paid off by the time you retire. Other
expenses, such as health-related expenses, may
increase in your later retirement years. A realistic esti-
mate of your expenses will tell you about how much
yearly income you’ll need to live comfortably.
Calculate the gap
Once you have estimated your retirement income
needs, take stock of your estimated future assets
and income. These may come from Social Security,
a retirement plan at work, a part-time job, and other
sources. If estimates show that your future assets and
income will fall short of what you need, the rest will
have to come from additional personal retirement
savings.
Figure out how much you’ll need to save
By the time you retire, you’ll need a nest egg that
will provide you with enough income to fill the gap
left by your other income sources. But exactly how
much is enough? The following questions may help
you find the answer:
• At what age do you plan to retire? The younger
you retire, the longer your retirement will be, and the
more money you’ll need to carry you through it.
• What is your life expectancy? The
longer you live, the more years of
retirement you’ll have to fund.
• What rate of growth can
you expect from your savings
now and during retirement?
Be conservative when pro-
jecting rates of return.
• Do you expect to
dip into your principal? If
so, you may deplete your
savings faster than if you
just live off investment earn-
ings. Build in a cushion to guard
against these risks.
Build your retirement fund: Save, save, save
When you know roughly how much money you’ll
need, your next goal is to save that amount. First,
you’ll have to map out a savings plan that works for
you. Assume a conservative rate of return (e.g., 5 per-
cent to 6 percent), and then determine approximately
how much you’ll need to save every year between
now and your retirement to reach your goal.
The next step is to put your savings plan into
action. It’s never too early to get started (ideally,
begin saving in your 20s). To the extent possible,
you may want to arrange to have certain amounts
taken directly from your paycheck and automatical-
ly invested in accounts of your choice (e.g., 401(k)
plans, payroll deduction savings). This arrangement