Chapter 4
Establishing and Achieving Goals
In This Chapter
Defining what matters most to you
Setting and prioritizing your financial goals
Saving for unexpected expenses, a real-estate purchase, a small business, or educational needs
Estimating what you need for retirement and making up for lost time
In my work as a financial counselor, I always asked new clients what their short- and long-term personal and financial goals were. Most people reported that reflecting on this question was incredibly valuable, because they hadn’t considered it for a long time — if ever.
In this chapter, I help you dream about what you want to get out of life. Although my expertise is in personal finance, I wouldn’t be doing my job if I didn’t get you to consider your nonfinancial goals and how money fits into the rest of your life goals. So before I jump into how to establish and save toward common financial goals, I discuss how to think about making and saving money, as well as how to best fit your financial goals into the rest of your life.
Creating Your Own Definition of “Wealth”
Peruse any major financial magazine, newspaper, or website and you’ll quickly see our culture’s obsession with financial wealth. The more money financial executives, movie stars, or professional athletes have, the more publicity and attention they seem to get. In fact, many publications go as far as ranking those people who earn the most or have amassed the greatest wealth!
I can tell you from my decades of work as a personal financial advisor and writer and interacting with folks from varied backgrounds that there’s surprisingly little correlation between financial wealth and emotional wealth. That’s why in your pursuit of financial wealth and security, you should always remember the emotional side. The following sections can help you gain some perspective.
Acknowledging what money can’t buy
Recall the handful of best moments in your life. Odds are these times don’t include the time you bought a car or found a designer sweater that you liked. The old saying is true: The most enjoyable and precious things of value in your life can’t be bought.
The following statement should go without saying, but I must say it, because too many people act as if it isn’t so: Money can’t buy happiness. It’s tempting to think that if you could only make 20 percent more or twice as much money, you’d be happier because you’d have more money to travel, eat out, and buy that new car you’ve been eyeing, right? Not so. A great deal of thoughtful research suggests that little relationship exists between money and happiness.
“Wealth is like health: Although its absence can breed misery, having it is no guarantee of happiness,” says psychology professor Dr. David G. Myers, who has written and researched happiness across cultures for decades. Despite myriad technological gadgets and communication devices, cheap air travel, microwaves, personal computers, voice mail, and all the other stuff that’s supposed to make life easier and more enjoyable, Americans aren’t any happier than they were four decades ago, according to research conducted by the National Opinion Research Center. These results occur even though incomes, after being adjusted for inflation, have more than doubled during that time.
Managing the balancing act
Believe it or not, some people save too much. In my counseling practice, I saw plenty of people who fell into that category. If making and saving money are good things, then the more the better, right? Well, take the admittedly extreme case of Anne Scheiber, who, on a modest income, started saving at a young age, allowing her money to compound in wealth-building investments such as stocks over many years. As a result, she was able to amass $20 million before she passed away at the age of 101.
Scheiber lived in a cramped studio apartment and never used her investments. She didn’t even use the interest or dividends — she lived solely on her Social Security benefits and a small pension from her employer. Scheiber was extreme in her frugality and obsessed with her savings. As reported by James Glassman in The Washington Post, “She had few friends . . . she was an unhappy person, totally consumed by her securities accounts and her money.” Most people, myself included, wouldn’t choose to live and save the way that Scheiber did.
Even those who are saving for an ultimate goal can become consumed by their saving habits. I see some people pursuing higher-paying jobs and pinching pennies in order to retire early. But sometimes they make too many personal sacrifices today while chasing after some vision of their lives tomorrow. Others get consumed by work and then don’t understand why their family and friends feel neglected — or don’t even notice that they do.
Another problem with seeking to amass wealth is that tomorrow may not come. Even if all goes according to plan, will you know how to be happy when you’re not working if you spend your entire life making money? More importantly, who will be around to share your leisure time? One of the costs of an intense career is time spent away from friends and family. You may realize your goal of retiring early, but you may be putting off too much living today in expectation of living tomorrow. As Charles D’Orleans said in 1465, “It’s very well to be thrifty, but don’t amass a hoard of regrets.”
Of course, at the other extreme are spendthrifts who live only for today. A friend of mine once said, “I’m not into delayed gratification.” “Shop ’til you drop” seems to be the motto of this personality type. “Why save when I might not be here tomorrow?” reasons this type of person.
The danger of this approach is that tomorrow may come after all, and most people don’t want to spend all their tomorrows working for a living. The earlier neglect of saving, however, may make it necessary for you to work when you’re older. And if for some reason you can’t work and you have little money to live on, much less live enjoyably, the situation can be tragic. The only difference between a person without any savings or access to credit and some homeless people is a few months of unemployment.
Making and saving money are like eating food. If you don’t eat enough, you may suffer. If you eat too much, the overage may go to waste or make you overweight. The right amount, perhaps with some extra to spare, affords you a healthy, balanced, peaceful existence. Money should be treated with respect and acknowledged for what it is — a means to an end and a precious resource that shouldn’t be thoughtlessly squandered and wasted.
As Dr. David Myers, whom I introduce earlier in this chapter, says: “Satisfaction isn’t so much getting what you want as wanting what you have. There are two ways to be rich: One is to have great wealth; the other is to have few wants.” Find ways to make the most of the money that does pass through your hands, and never lose sight of all that is far more important than money.
Prioritizing Your Savings Goals
Most people I know have financial goals. The rest of this chapter discusses the most common financial goals and how to work toward them. See whether any of the following reflect your ambitions:
Owning your home: Renting and dealing with landlords can be a financial and emotional drag, so most folks want to buy into the American dream and own some real estate — the most basic of which is your own home. (Despite the slide in property prices in the late 2000s, real estate has a pretty solid track record as a long-term investment.)
Making major purchases: Most folks need to plan ahead for major purchases such as a car, living room furniture, vacation trips, and so on.
Retiring: No, retiring doesn’t imply sitting on a rocking chair watching the world go by while hoping that some long-lost friend, your son’s or daughter’s family, or the neighborhood dog comes by to visit. Retiring is a catchall term for discontinuing full-time work or perhaps not even working for pay at all.
Educating the kids: All those diaper changes, late-night feedings, and trips to the zoo aren’t enough to get Junior out of your house and into the real world as a productive, self-sufficient adult. You may want to help your children get a college education. Unfortunately, that can cost a truckload of dough.
Owning your own business: Many employees want to take on the challenges and rewards that come with being the boss. The primary reason that most people continue just to dream is that they lack the money to leave their primary job. Although many businesses don’t require gobs of start-up cash, almost all require that you withstand a substantial reduction in your income during the early years.
Because everyone is different, you can have goals (other than those in the preceding list) that are unique to your own situation. Accomplishing such goals almost always requires saving money. As one of my favorite Chinese proverbs says, “Do not wait until you are thirsty to dig a well,” so don’t wait to save money until you’re ready to accomplish a personal or financial goal!
Knowing what’s most important to you
Unless you earn really big bucks or have a large family inheritance to fall back on, your personal and financial desires will probably outstrip your resources. Thus, you must prioritize your goals.
One of the biggest mistakes I see people make is rushing into a financial decision without considering what’s really important to them. Because many people get caught up in the responsibilities of their daily lives, they often don’t have time for reflection.
As a result of my experience counseling and teaching people about better personal financial management, I can tell you that the folks who accomplish their goals aren’t necessarily smarter or higher-income earners than those who don’t. People who identify their goals and then work toward them, which often requires changing some habits, are the ones who accomplish their goals.
Valuing retirement accounts
Where possible, try to save and invest in accounts that offer you a tax advantage, which is precisely what retirement accounts offer you. These accounts — known by such enlightening acronyms and names as 401(k), 403(b), SEP-IRAs, Keoghs, and so on — offer tax breaks to people of all economic means. Consider the following advantages to investing in retirement accounts:
Contributions are usually tax-deductible. By putting money in a retirement account, not only do you plan wisely for your future, but you also get an immediate financial reward: lower taxes, which mean more money available for saving and investing. Retirement account contributions generally aren’t taxed at either the federal or state income tax level until withdrawal (but they’re still subject to Social Security and Medicare taxes when earned). If you’re paying, say, 35 percent between federal and state taxes (see Chapter 7 to determine your tax bracket), a $5,000 contribution to a retirement account lowers your taxes by $1,750.
In some company retirement accounts, companies match a portion of your own contributions. Thus, in addition to tax breaks, you get free extra money courtesy of your employer!
Returns on your investment compound over time without taxation. After you put money into a retirement account, any interest, dividends, and appreciation add to your account without being taxed. Of course, there’s no such thing as a free lunch — these accounts don’t allow for complete tax avoidance. Yet you can get a really great lunch at a discount: You get to defer taxes on all the accumulating gains and profits until you withdraw the money down the road. Thus, more money is working for you over a longer period of time. (The newer Roth IRA that I discuss in Chapter 11 offers no upfront tax breaks but does allow future tax-free withdrawal of investment earnings.)
The tax rates on stock dividends and long-term capital gains (investments held more than one year) are lower than the tax rates levied on ordinary income (such as that earned through working). This fact makes some people think that investing through retirement accounts may not be worthwhile because all investment earnings are taxed at the relatively high ordinary income tax rates when money is withdrawn from retirement accounts. I’ll cut to the chase: The vast majority of people are better off contributing to retirement accounts (please see Chapter 7 for more details).
Dealing with competing goals
Unless you enjoy paying higher taxes, why would you save money outside of retirement accounts, which shelter your money from taxation? The reason is that some financial goals are not easily achieved by saving in retirement accounts. Also, retirement accounts have caps on the amount you can contribute annually.
If you’re accumulating money for a down payment on a home or to start or buy a business, for example, you’ll probably need to save that money outside of a retirement account. Why? Because if you withdraw funds from retirement accounts before age 591⁄2 and you’re not retired, not only do you have to pay income taxes on the withdrawals, but you also generally have to pay early withdrawal penalties — 10 percent of the withdrawn amount in federal tax plus whatever your state charges. (See the sidebar “Avoiding retirement account early withdrawal penalties” for exceptions to this rule.)
Because you’re constrained by your financial resources, you need to prioritize your goals. Before funding your retirement accounts and racking up those tax breaks, read on to consider your other goals.
Building Emergency Reserves
Because you don’t know what the future holds, preparing for the unexpected is financially wise. Even if you’re the lucky sort who sometimes finds $5 bills on street corners, you can’t control the sometimes chaotic world in which we live.
Conventional wisdom says that you should have approximately six months of living expenses put away for an emergency. This particular amount may or may not be right for you, because it depends, of course, on how expensive the emergency is. Why six months, anyway? And where should you put it?
How much of an emergency stash you need depends on your situation. I recommend saving the following emergency amounts under differing circumstances (in Chapter 12, I recommend preferred places to invest this money):
Three months’ living expenses: Choose this option if you have other accounts, such as a 401(k), or family members and close friends whom you can tap for a short-term loan. This minimalist approach makes sense when you’re trying to maximize investments elsewhere (for example, in retirement accounts) or you have stable sources of income (employment or otherwise).
Six months’ living expenses: This amount is appropriate if you don’t have other places to turn for a loan or you have some instability in your employment situation or source of income.
Up to one year’s living expenses: Set aside this much if your income fluctuates wildly from year to year or if your profession involves a high risk of job loss, finding another job could take you a long time, and you don’t have other places to turn for a loan.
In the event that your only current source of emergency funds is a high-interest credit card, first save at least three months’ worth of living expenses in an accessible account before funding a retirement account or saving for other goals.
Saving to Buy a Home or Business
When you’re starting out financially, deciding whether to save money to buy a home or to put money into a retirement account presents a dilemma. In the long run, owning your own home is a wise financial move. On the other hand, saving sooner for retirement makes achieving your goals easier.
Presuming both goals are important to you, save toward both buying a home and for retirement. If you’re eager to own a home, you can throw all your savings toward achieving that goal and temporarily put your retirement savings on hold. Save for both purposes simultaneously if you’re not in a rush.
You may be able to have the best of both worlds if you work for an employer that allows borrowing against retirement account balances. You can save money in the retirement account and then borrow against it for the down payment of a home. Be extra careful, though. Retirement account loans typically must be paid back within a set number of years (check with your employer) or immediately if you quit or lose your job. As I mention earlier in this chapter, you’re also allowed to make penalty-free withdrawals of up to $10,000 from individual retirement accounts toward a first-time home purchase.
When saving money for starting or buying a business, most people encounter the same dilemma they face when deciding to save to buy a house: If you fund your retirement accounts to the exclusion of earmarking money for your small-business dreams, your entrepreneurial aspirations may never become a reality. Generally, I advocate hedging your bets by saving money in your tax-sheltered retirement accounts as well as toward your business venture. As I discuss in Part III, an investment in your own small business can produce great rewards, so you may feel comfortable focusing your savings on your own business.
Funding Kids’ Educational Expenses
Wanting to provide for your children’s future is perfectly natural, but doing so before you’ve saved adequately toward your own goals can be a major financial mistake. The college financial-aid system effectively penalizes you for saving money outside of retirement accounts and penalizes you even more if the money’s invested in the child’s name.
This concept may sound selfish, but you need to take care of your future first. Take advantage of saving through your tax-sheltered retirement accounts before you set aside money in custodial savings accounts for your kids. This practice isn’t selfish: Do you really want to have to leech off your kids when you’re old and frail because you didn’t save any money for yourself? (See Chapter 13 for a complete explanation of how to save for educational expenses.)
Saving for Big Purchases
If you want to buy a car, a canoe, and a plane ticket to Thailand, do not, I repeat, do not buy such things with consumer credit (that is, carry debt month-to-month to finance the purchase on a credit card or auto loan). As I explain in Chapter 5, cars, boats, vacations, and the like are consumer items, not wealth-building investments, such as real estate or small businesses. A car begins to depreciate the moment you drive it off the sales lot. A plane ticket is worthless the moment you arrive back home. (I know your memories will be priceless, but they won’t pay the bills.)
Don’t deny yourself gratification; just learn how to delay it. Get into the habit of saving for your larger consumer purchases to avoid paying for them over time with high-interest consumer credit. When saving up for a consumer purchase such as a car, a money-market account or short-term bond fund (see Chapter 12) is a good place to store your short-term savings.
Paying for high-interest consumer debt can cripple your ability not only to save for long-term goals but also to make major purchases in the future. Interest on consumer debt is exorbitantly expensive — upwards of 20 percent on credit cards. When contemplating the purchase of a consumer item on credit, add up the total interest you’d end up paying on your debt and call it the price of instant gratification.
Preparing for Retirement
Many people toil away at work, dreaming about a future in which they can stop the daily commute and grind; get out from under that daily deluge of voice mails, e-mails, and other never-ending technological intrusions; and do what they want, when they want. People often assume that this magical day will arrive either on their next true day off or when they retire or win the lottery — whichever comes first.
I’ve never cared much for the term retire, which seems to imply idleness or the end of usefulness to society. But if retirement means not having to work at a job (especially one you don’t enjoy) and having financial flexibility and independence, then I’m all for it.
Many folks aspire to retire sooner rather than later. But this idea has some obvious problems. First, you set yourself up for disappointment. If you want to retire by your mid-60s (when Social Security kicks in), you need to save enough money to support yourself for 20 to 30 years, maybe longer. Two to three decades is a long time to live off your savings. You’re going to need a good-sized chunk of money — more than most people realize.
The earlier you hope to retire, the more money you need to set aside and the sooner you have to start saving — unless you plan to work part-time in retirement to earn more income! See Chapter 11 for more details about how to save for retirement.
Many of the people I speak to say that they do want to retire, and most say “the sooner, the better.” Yet more than half of Americans between the ages of 18 and 34, and a quarter of those ages 35 to 54, have not begun to save for retirement. When I asked one of my middle-aged counseling clients, who had saved little for retirement, when he would like to retire, he deadpanned, “Sometime before I die.” If you’re in this group (and even if you’re not), determine where you stand financially regarding retirement. If you’re like most working people, you need to increase your savings rate for retirement.
Figuring out what you need for retirement
If you hope to someday reduce the time you spend working or cease working altogether, you’ll need sufficient savings to support yourself. Many people — particularly young people and those who don’t work well with numbers — underestimate the amount of money needed to retire. To figure out how much you should save per month to achieve your retirement goals, you need to crunch a few numbers. (Don’t worry — this number-crunching is usually easier than doing your taxes.)
Don’t neglect nonfinancial preparations for retirement
Investing your money is just one (and not even the most important) aspect of preparing for your retirement. In order to enjoy the lifestyle that your retirement savings will provide you, you need to invest energy into other areas of your life as well:
Few things are more important than your health. Without your health, enjoying the good things in life can be hard. Unfortunately, many people aren’t motivated to care about their health until after they discover problems. By then, it may be too late.
Although exercising regularly, eating a balanced and nutritious diet, and avoiding substance abuse can’t guarantee you a healthful future, these good habits go a long way toward preventing many of the most common causes of death and debilitating disease. Regular medical exams also are important in detecting problems early.
In addition to your physical health, be sure to invest in your psychological health. People live longer and have happier and healthier lives when they have a circle of family and friends around them for support.
Unfortunately, many people become more isolated and lose regular contact with business associates, friends, and family members as they grow older.
Happy retirees tend to stay active, getting involved in volunteer organizations and new social circles. They may travel to see old friends or younger relatives who may be too busy to visit them.
Treat retirement life like a bubbly, inviting hot tub set at 102 degrees. You want to ease yourself in nice and slow; jumping in hastily can take most of the pleasantness out of the experience. Abruptly leaving your job without a plan for spending all that free time is an invitation to boredom and depression. Everyone needs a sense of purpose and a sense of routine. Establishing hobbies, volunteer work, or a sideline business while gradually cutting back your regular work schedule can be a terrific way to ease into retirement.
Luckily for you, you don’t have to start cold. Studies show how people typically spend money before and during retirement. Most people need about 70 to 80 percent of their pre-retirement income throughout retirement to maintain their standard of living. For example, if your household earns $50,000 per year before retirement, you’re likely to need $35,000 to $40,000 (70 to 80 percent of $50,000) per year during retirement to live the way you’re accustomed to living. The 70 to 80 percent is an average. Some people may need more simply because they have more time on their hands to spend their money. Others adjust their standard of living and live on less.
So how do you figure out what you’re going to need? The following three profiles provide a rough estimate of the percentage of your pre-retirement income you’re going to need during retirement. Pick the one that most accurately describes your situation. If you fall between two descriptions, pick a percentage in between those two.
To maintain your standard of living in retirement, you may need about:
65 percent of your pre-retirement income if you
• Save a large amount (15 percent or more) of your annual earnings
• Are a high-income earner
• Will own your home free of debt by the time you retire
• Do not anticipate leading a lifestyle in retirement that reflects your current high income
If you’re an especially high-income earner who lives well beneath your means, you may be able to do just fine with even less than 65 percent. Pick an annual dollar amount or percentage of your current income that will allow the kind of retirement lifestyle you desire.
75 percent of your pre-retirement income if you
• Save a reasonable amount (5 to 14 percent) of your annual earnings
• Will still have some mortgage debt or a modest rent to pay by the time you retire
• Anticipate having a standard of living in retirement that’s comparable to what you have today
85 percent of your pre-retirement income if you
• Save little or none of your annual earnings (less than 5 percent)
• Will have a relatively significant mortgage payment or sizeable rent to pay in retirement
• Anticipate wanting or needing to maintain your current lifestyle throughout retirement
Of course, you can use a more precise approach to figure out how much you need per year in retirement. Be forewarned, though, that using a more-personalized method is far more time-consuming, and because you’re making projections into an uncertain future, it may not be any more accurate than the simple method I explain here. If you’re data-oriented, you may feel comfortable tackling this method: Figure out where you’re spending your money today (worksheets are available in Chapter 3) and then work up some projections for your expected spending needs in retirement (the information in Chapter 19 may help you, as well).
Understanding retirement building blocks
Did you play with Lego blocks or Tinkertoys when you were a child? You start by building a foundation on the ground, and then you build up. Before you know it, you’re creating bridges, castles, and animal figures. Although preparing financially for retirement isn’t exactly like playing with blocks, the concept is the same: You need a basic foundation so that your necessary retirement reserves can grow.
If you’ve been working steadily, you may already have a good foundation, even if you haven’t been actively saving toward retirement. In the pages ahead, I walk you through the probable components of your future retirement income and show you how to figure how much you should be saving to reach particular retirement goals.
Counting on Social Security
According to polls, nearly half of American adults under the age of 35, and more than a third of those between the ages of 35 and 49, think that Social Security benefits will not be available by the time they retire.
Contrary to widespread skepticism, Social Security should be available when you retire, no matter how old you are today. In fact, Social Security is one of the sacred cow political programs. Imagine what would happen to the group of politicians who voted to greatly curtail benefits! (Congress may make some reductions in benefits, probably for the highest income earners, at some point due to the federal debt problems.)
If you think that you can never retire because you don’t have any money saved, I’m happy to inform you that you’re probably wrong. You likely have some Social Security. But Social Security generally isn’t enough to live on comfortably.
Social Security is intended to provide you with a subsistence level of retirement income for the basic necessities: food, shelter, and clothing. Social Security is not intended to be your sole source of income. Some of the elderly are quite dependent upon Social Security: It’s the only source of income for 22 percent of the elderly, and two out of three Social Security recipients derive at least half of their total retirement income from their Social Security retirement check. Few working people can maintain their current lifestyles into retirement without supplementing Social Security with personal savings and company retirement plans.
How much work makes me eligible?
To be eligible to collect Social Security benefits, you need to have worked a minimum number of calendar quarters. If you were born after 1928, you need 40 quarters of work credits to qualify for Social Security retirement benefits.
If, for some reason, you work only the first half of a year or only during the summer months, don’t despair. You don’t need to work part of every quarter to get a quarter’s credit. You get credits based on the income you earn during the year. As of this writing, you get the full four quarters credited to your account if you earn $4,520 or more in a year. (Prior to 1978, workers got one quarter’s credit for each actual calendar quarter in which they earned $50.) To get 40 quarters of coverage, you basically need to work (at least portions of) ten years.
To get credits, your income must be reported and you must pay taxes on it (including Social Security tax). In other words, you and those you employ encounter problems when you neglect to declare income or you pay people under the table: You may be cheating yourself, or others, out of valuable benefits.
How much will I get from Social Security?
The average monthly benefit Social Security pays out to retirees is about $1,180. The higher your employment earnings have been on average, the more you can expect to receive. If you’re married and one of you doesn’t work for pay, the nonworking spouse collects 50 percent of what the working spouse collects. Working spouses are eligible for either individual benefits or half of their spouse’s benefits — whichever amount is greater.
To get a more precise handle on your Social Security benefits, call the Social Security Administration at 800-772-1213 and ask for Form 7004, which allows you to receive a record of your reported earnings and an estimate of your Social Security benefits. (You can also visit the Social Security Administration website at www.ssa.gov.) Check your earnings record, because occasional errors do arise and — surprise — they usually aren’t in your favor.
Planning your personal savings/investment strategy
Money you’re saving toward retirement can include money under the mattress as well as money in a retirement account such as an individual retirement account (IRA), 401(k), or similar plan (see Chapter 11). You may also earmark investments in nonretirement accounts for your retirement.
Equity (the difference between the market value less any mortgage balances owed) in rental real estate can be counted toward your retirement as well. Deciding whether to include the equity in your primary residence (your home) is trickier. If you don’t want to count on using this money in retirement, don’t include it when you tally your stash. You may want to count a portion of your home equity in your total assets for retirement. Many people sell their homes when they retire and move to a lower-cost area, move closer to family, or downsize to a more manageable size home. And increasing numbers of older retirees are tapping their homes’ equity through reverse mortgages (see Chapter 14 for information on mortgages).
Making the most of pensions
Pension plans are a benefit offered by some employers — mostly larger organizations and government agencies. Even if your current employer doesn’t offer a pension, you may have earned pension benefits through a previous job.
The plans I’m referring to are known as defined-benefit plans. With these plans, you qualify for a monthly benefit amount to be paid to you in retirement based on your years of service for a specific employer.
Although each company’s plan differs, all plans calculate and pay benefits based on a formula. A typical formula may credit you with 1.5 percent of your salary for each year of service (full-time employment). For example, if you work ten years, you earn a monthly retirement benefit worth 15 percent of your monthly salary.
Pension benefits can be quite valuable. In the better plans, employers put away the equivalent of 5 to 10 percent of your salary to pay your future pension. This money is in addition to your salary — you never see it in your paycheck, and it isn’t taxed. The employer puts this money away in an account for your retirement.
To qualify for pension benefits, you don’t have to stay with an employer long enough to receive the 25-year gold watch. Under current government regulations, employees must be fully vested (entitled to receive full benefits based on years of service upon reaching retirement age) after five years of full-time service.
Defined-benefit pension plans are becoming rarer for two major reasons:
They’re costly for employers to maintain. Many employees don’t understand how these plans work and why they’re so valuable, so companies don’t get mileage out of their pension expenditures — employees don’t see the money, so they don’t appreciate the company’s generosity.
Most of the new jobs being generated in the U.S. economy are with small companies that typically don’t offer these types of plans.
More employers offer plans like 401(k)s, in which employees elect to save money out of their own paychecks. Known as defined-contribution plans, these plans allow you to save toward your retirement at your own expense rather than at your employer’s expense. (To encourage participation in defined-contribution plans, some employers “match” a portion of their employees’ contributions.) More of the burden and responsibility of investing for retirement falls on your shoulders with 401(k) and similar plans, so understanding how these plans work is important. Most people are ill-equipped to know how much to save and how to invest the money. The retirement planning worksheet in the next section can help you get started with figuring out the amount you need to save. (Part III shows you how to invest.)
Crunching numbers for your retirement
Now that you’ve toured the components of your future retirement income, take a shot at tallying where you stand in terms of retirement preparations. Don’t be afraid to do this exercise — it’s not difficult, and you may find that you’re not in such bad shape. I even explain how to catch up if you find that you’re behind in saving for retirement.
Note: The following worksheet (Table 4-1) and the Growth Multiplier (Table 4-2) assume that you’re going to retire at age 66 and that your investments will produce an annual rate of return that is 4 percent higher than the rate of inflation. (For example, if inflation averages 3 percent, this table assumes that you will earn 7 percent per year on your investments.)
To get a more precise handle on where you stand in terms of retirement planning (especially if you’d like to retire earlier than your mid-60s), call T. Rowe Price at 800-638-5660 and ask for the company’s retirement planning booklets. You can also turn to Chapter 19, where I recommend retirement planning software and websites that can ease your number-crunching burdens.
Table 4-2 Growth Multiplier
|
Your Current Age |
Growth Multiplier |
Savings Factor |
|
26 |
4.8 |
0.001 |
|
28 |
4.4 |
0.001 |
|
30 |
4.1 |
0.001 |
|
32 |
3.8 |
0.001 |
|
34 |
3.5 |
0.001 |
|
36 |
3.2 |
0.001 |
|
38 |
3.0 |
0.002 |
|
40 |
2.8 |
0.002 |
|
42 |
2.6 |
0.002 |
|
44 |
2.4 |
0.002 |
|
46 |
2.2 |
0.003 |
|
48 |
2.0 |
0.003 |
|
50 |
1.9 |
0.004 |
|
52 |
1.7 |
0.005 |
|
54 |
1.6 |
0.006 |
|
56 |
1.5 |
0.007 |
|
58 |
1.4 |
0.009 |
|
60 |
1.3 |
0.013 |
|
62 |
1.2 |
0.020 |
|
64 |
1.1 |
0.041 |
Making up for lost time
If the amount you need to save per month to reach your retirement goals seems daunting, all is not lost. Remember: Winners never quit, and quitters never win. Here are my top recommendations for making up for lost time:
Question your spending. You have two ways to boost your savings: Earn more money or cut your spending (or do both). Most people don’t spend their money nearly as thoughtfully as they earn it. See Chapter 6 for suggestions and strategies for reducing your spending.
Be more realistic about your retirement age. If you extend the age at which you plan to retire, you get a double benefit: You earn and save money for more years, and you spend your nest egg over fewer years. Of course, if your job is making you crazy, this option may not be too appealing. Try to find work that makes you happy, and consider working, at least part-time, during your “early” retirement years.
Use your home equity. The prospect of tapping the cash in your home can be troubling. After getting together the down payment, you probably worked for many years to pay off that sucker. You’re delighted not to have to mail a mortgage payment to the bank anymore. But what’s the use of owning a house free of mortgage debt when you lack sufficient retirement reserves? All the money that’s tied up in the house can be used to help increase your standard of living in retirement.
You have a number of ways to tap your home’s equity. You can sell your home and either move to a lower-cost property or rent an apartment. Current tax laws allow you to realize up to $250,000 in tax-free profit from the sale of your house ($500,000 if you’re married). Another option is a reverse mortgage, in which you get a monthly income check as you build a loan balance against the value of your home. The loan is paid when your home is finally sold. (See Chapter 14 for more information about reverse mortgages.)
Get your investments growing. The faster the rate at which your money grows and compounds, the less you need to save each year to reach your goals. (Make sure, however, that you’re not reckless; don’t take huge risks in the hopes of big returns.) Earning just a few extra percentage points per year on your investments can dramatically slash the amount you need to save. The younger you are, the more powerful the effect of compounding interest. For example, if you’re in your mid-30s and your investments appreciate 6 percent per year (rather than 4 percent) faster than the rate of inflation, the amount you need to save each month to reach your retirement goals drops by about 40 percent! (See Part III for more on investing.)
Turn a hobby into supplemental retirement income. Even if you earn a living in the same career over many decades, you have skills that are portable and can be put to profitable use. Pick something you enjoy and are good at, develop a business plan, and get smart about how to market your services and wares (check out the latest edition of Small Business For Dummies from Wiley, which I co-wrote with veteran entrepreneur Jim Schell). Remember, as people get busier, more specialized services are created to support their hectic lives. A demand for quality, homemade goods of all varieties also exists. Be creative! You never know — you may wind up profiled in a business publication!
Invest to gain tax-free and other free money. By investing in a tax-wise fashion, you can boost the effective rate of return on your investments without taking on additional risk.
In addition to the tax benefits you gain from funding most types of retirement accounts in this chapter (see the earlier section, “Valuing retirement accounts”), some employers offer free matching money. Also, the government now offers tax credits (see Chapter 7) for low and moderate income earners who utilize retirement accounts.
As for money outside of tax-sheltered retirement accounts, if you’re in a relatively high tax bracket, you may earn more by investing in tax-free investments and other vehicles that minimize highly taxed distributions.
Think about inheritances. Although you should never count on an inheritance to support your retirement, you may inherit money someday. If you want to see what impact an inheritance has on your retirement calculations, add a conservative estimate of the amount you expect to inherit to your current total savings in Table 4-1.