Key Numbers to Know for Retirement Planning

If you are age 45 or over and haven’t started seriously funding your IRA, 401(K) or other retirement accounts yet, then it’s time to sound the alarm! This may be your last chance to be able to save enough money to meet your retirement needs, and even then it’s going to be far more painful than if you had started earlier in life. 

By “painful,” what I mean is that if you have no significant retirement savings yet, you are going to have to take some drastic steps. While someone starting to save at age 25 only needs to put aside 15 percent of salary for retirement (see below), a study by the Center for Retirement Research at Boston College found that those who wait until age 45 to start will need to put aside 41 percent of their income each year to meet their retirement goals. That’s a tall order!

For late starters, saving for retirement must become your No. 1 financial goal. That means saving for retirement comes before spending money on vacations, hobbies, or that nice new car or pickup truck you want. Until your retirement accounts are fully funded each year, don’t even think about visiting a boat or RV showroom! Taking a second job may be necessary to find the money you need to save for retirement.

Starting at age 50, the IRS allows you to save even more money each year in tax-advantaged retirement accounts. This is what’s known as the catch-up provision. For the 2021 and 2022 tax years, you can contribute up to $1,000 extra each year to an IRA and up to $6,500 extra into a 401(k). 

If you ask how much you should be saving for retirement, the most common answer from retirement experts is 15 percent of your annual income. It’s a good yardstick for most people, but your situation may vary. For instance, if you are starting late in saving for retirement, such as age 35 or higher, you will need to save more, as discussed above. An analysis by Fidelity estimates that while saving 15 percent is sufficient for someone starting to save for retirement beginning at age 25, for someone who procrastinates and doesn’t start saving until age 35 the percentage jumps to 23 percent. The older you are when you seriously start saving for retirement, the higher the percentage of your total income you will have to devote to that goal. 

Another factor that will impact how much you need to save is knowing when you want to retire. Most of the standard calculations assume you plan to retire between the ages of 65 to 67. What if you want to retire at 50? Obviously, you will need to be much more aggressive about how much money you save each year to fund an early retirement. 

Everyone likes safety and guarantees, but when saving for retirement, you have to accept some risk to get ahead. The 10-year U.S. Treasury bond is yielding just shy of 2 percent at the time this story was written. Many bank certificates of deposit (CDs) and money market accounts pay even less. At 2 percent or similar low rates, your money won’t even keep up with inflation, let alone build wealth. 

Professor Aswath Damodaran, a respected finance professor at New York University, publishes an annual update on the total returns since 1928 of the U.S. stock market (S&P 500), bonds (10-year treasuries), and short-term investments most similar to bank CDs and money market accounts (three-month t-bills). Over that long period of time, which includes the Great Depression, World War II, and the 2008 stock crash, stocks averaged a total annual return of 10 percent, bonds 4.8 percent, and cash 3.3 percent. 

These results explain why many retirement advisers recommend putting the largest portion of your retirement money into a diversified group of good-quality stocks during your working years. “Safe” investments like bank savings, bonds, insurance fixed annuities, and money market accounts are not likely to outpace inflation or grow wealth over the longer haul. 

While stocks are a great option for growth-focused retirement accounts, don’t make the mistake of investing too heavily in your employer’s stock. The fortunes of any individual company can change, sometimes quickly, no matter how stellar its past performance. Just ask your uncle or grandparent who worked a generation ago for companies like Eastman Kodak, Sears & Roebuck, or Eastern Airlines. More recently, remember Blockbuster Video, MySpace, and Blackberry? It’s very risky to invest a large percentage of your retirement money in any one stock, including stock of the company where you work.

How much of your retirement savings should be invested in common stocks? That’s a highly debatable question, but the answer is determined in part by your age and when you plan to retire. Most experts would say that a 30-year-old who plans to work until 65 to 70 should be heavily invested in stocks. As you near retirement and become more concerned about risk of principal loss, you gradually scale back the percent of your total portfolio invested in stocks. The traditional wisdom is that a 65-year-old getting ready to retire should follow the 60/40 Rule, with 60 percent of their portfolio in stocks and 40 percent in bonds. 

Like most rules of thumb, whether this is how you should invest depends on many variables. For starters, what is your risk tolerance? Will investing 60 percent of your portfolio in stocks at age 65 cause you anxiety and stress as the markets fluctuate in value? Then maybe you need to invest less in stocks. Do you have sufficient retirement income from other sources such as pensions, annuities, rental income, or other investments? In that case, you can afford to accept greater risk with your IRA or 401(k) and invest a higher percent in stocks.

The Rule of 72 is a mathematical formula for estimating how fast your savings will double at different rates of return. It demonstrates the power of compounding and why it matters how soon you start investing and how much you earn on your IRA or 401(k). 

To use the Rule of 72, take the number 72 and divide it by the assumed interest rate your portfolio might earn. The answer shows how many years it will take your money to double. 

Using the numbers above from Professor Damodaran’s research, let’s look at two examples. If you invested in “safe” cash investments and averaged 3.3 percent annually, your money would take nearly 22 years to double. That’s a long time! On the other hand, if you invested in stocks and averaged 10 percent, using the Rule of 72 your money would double in only 7 years! Over a long period of time, how you invest can have a profound impact on how much you accumulate for retirement during your working career.  

Here’s another example using the Rule of 72. Assume you have $50,000 invested in your IRA or 401(k) account by age 35. You plan to retire at age 67. To keep our math simple, let’s assume you never make any additional contributions.

Here are how the numbers look:

Value of IRA at age 67 using “safe” investments averaging 3% annually, doubling every 24 years (72 ÷ 3 = 24): $128,754

OR

Value of IRA at age 67 using “growth” investments like stocks averaging 7% annually, doubling every 10 years (72 ÷ 7 = 10): $435,763

How you invest matters!

Age 59 1/2 is the earliest age you can begin to pull money from your IRA and some other retirement accounts without incurring a punishing penalty. You should avoid withdrawing any money from your IRA or 401(k) prior to this age. 

Even when you reach 59 1/2, for most people it makes no sense to start pulling money from your retirement accounts if you are still working. Don’t touch your retirement savings until you retire. Avoid the temptation during your working years of using your IRA as a piggy bank to fund big-ticket items on your wish list. Never pull money from your IRA, prior to retirement, to buy an RV, boat, motorcycle, or a new car. Find another way to fund those purchases or do without. 

Keep in mind that you will still owe income taxes on the amount withdrawn from your retirement account, regardless of your age. The exception is for ROTH accounts, where withdrawals are tax free. If you wait until age 59 1/2 or later to withdraw money from a traditional IRA or 401(k), you avoid the tax penalty but it still counts as taxable income when you do withdraw. 

Age 62 was once the most common age for applying to start Social Security benefits, but thankfully the message seems to be getting through that this is not the best timing for most senior adults. Age 62 is the earliest age you can begin receiving Social Security retirement benefits. Doing so, however, reduces the size of your monthly Social Security checks for the rest of your life. If your full retirement age is 66, you will receive a permanent 25 percent reduction in your Social Security checks if you start drawing your benefits at age 62. If your full retirement age is 67, the reduction is 30 percent. 

Today, less than one-third of people sign up for Social Security at age 62, down from over 50 percent in 2005, according to Social Security Administration data. That is a positive trend, perhaps bolstered by the fact that more seniors are choosing to continue working later in life.

While in general it’s best to wait until at least your full retirement age to start drawing Social Security, there are exceptions:

• If you are laid off from a job in your early 60s, can’t find a new job, and need the money to support yourself or your family, then you may have no choice but to start drawing Social Security benefits early. 
• People with relatively low salaries over the years compared with their spouse may opt to start their Social Security check at age 62 knowing they can switch later to receiving half of their spouse’s Social Security check (but with some reduction of benefits). 
• If you have a serious disease that is likely to significantly shorten your life, then opting to start Social Security benefits early may make good financial sense. 

For U.S. senior adults, age 65 is a huge milestone. It is the year when you can begin to receive Medicare for health insurance. Many people who want to retire sooner wait until they turn 65 because of Medicare. Sign up three months prior to your 65th birthday online (the easiest way) on the Social Security website, call your local Social Security office, or call Medicare at 1-800-772-1213. 

For most seniors in the Baby Boomer generation, age 66 or 67 is your full retirement age for Social Security purposes. If you were born between 1943 and 1954, your full retirement age is 66. If born in 1960 and later, your full retirement age is 67. For those born in 1955 – 1959, your “FRA” as Social Security calls it falls between ages 66 and 67, such as 66 years and two months, 66 and four months, etc. The FRA age is now the most popular time for starting to draw Social Security retirement benefits. 

But wait, you still may not want to start drawing Social Security benefits just yet, even at your FRA. See the next entry to learn why.

While you can begin receiving Social Security retirement benefits as early as age 62, to get the maximum benefit you should wait until age 70 to start, if your circumstances allow you to do so. The monthly amount of Social Security you will receive goes up 8 percent for each year that you delay starting benefits between your full retirement age and age 70. That means if you wait until age 70 versus age 66 to start receiving your check, you will receive 32 percent more money each month than you would had at 66. That’s significant! Where else can you earn a guaranteed 8 percent per year on your money? 

It’s also worth noting that this higher amount of Social Security income is permanent. You will earn more each month for the remainder of your life. If you are married and you die first, your spouse will continue to receive this higher check each month, provided he or she chooses to draw from your Social Social earnings rather than from their own. 

Not everyone can wait until age 70 to start Social Security, but if you are still working or can support yourself from pension plans, annuities, other investments, or a spouse’s income, then it pays to wait. 

If you reached age 70 1/2 in 2020 or later, you can delay until age 72 starting to make mandatory annual withdrawals from your IRA, 401(k) and most other tax-deferred retirement savings accounts. The IRS refers to these withdrawals as Required Minimum Distributions, or RMDs. One of the benefits of traditional IRA, 401(k) and other retirement accounts is that during your working years the contributions you make and the growth within the account are all tax-advantaged.  No matter how much your account earns from year to year, the IRS doesn’t require you to pay income tax on it during this accumulation phase. When you reach age 72, however, Uncle Sam wants to start collecting his tax money. Prior to 2020, RMDs began at age 70 1/2.

With RMDs, the government says you must remove a small portion of your retirement account each year. The amount you must withdraw is based on life expectancy and increases as you age. The IRS publishes an RMD table each year, showing the current rates. 

Let’s say you turn 72 in 2022. The amount the IRS says you must withdraw from your account this year is about 3.6 percent of your account’s value at the end of last year, using the government’s Uniform Lifetime Table. If you had $500,000 in your IRA or 401(k) account at the end of last year, then you would be required to withdraw $18,248 this year. Of course you may withdraw more, but this is the amount the IRS says you must withdraw. 

By the way, this is a deadline you don’t want to miss. The penalty for failing to take your RMD is a 50 percent tax on any amount you failed to withdraw during that calendar year. Using the above example, if you didn’t take any of your $18,248 RMD, you would owe a tax penalty of $9,124. Ouch!

Your Key Retirement Numbers

Armed with these key numbers for retirement planning, you can do a better job planning for or managing your own retirement. It’s one of the most important financial goals of your lifetime, so it pays to learn these numbers well and make retirement planning a priority. 

* * * * *

Disclaimer: The above article is meant for educational purposes only and should not be construed as offering professional tax or investment advice. Please consult with qualified professionals before making any investment or tax decisions. While we believe the information is accurate at the time of publication, keep in mind that tax laws change over time. 

Got comments? What are your best tips for retirement planning? Please scroll down and add your comments in the section below. 

* * * * *

Subscribe via email for free to receive all future stories from This Retirement Life. Our blog explores topics of interest to retirees and those planning for retirement. Please see subscription information to the right of this story or below, and sign up today.