How Much Should I Save for Retirement?

Things have changed a lot in 230 years or so.

At the time of the American Revolution, life expectancy at birth was 23 years. By 1900 it had climbed to only 47 years. If you were alive, you worked. There was no such thing as retirement. Today, though, life expectancy at birth is 76; today's 76-year-olds have a life expectancy of 86. According to some estimates, by the year 2005, half of all deaths in the U.S. will occur after age 80. These life expectancies are a big part of why we need to plan.

Why are these figures important? Well, if you're wondering how much money you'll need in retirement to avoid running out of money during your lifetime, you need to project how long that lifetime will be. Based on data provided by various government agencies, most financial planners assume their clients will live to age 85, and conservative planners use age 90, just to be safe (the longer you live, the more money you'll need).

Consider food. Assuming you and your spouse retire at 65 and live to your normal life expectancy of 85, you're going to eat 43,800 meals in retirement! (That's three meals a day, 365 days a year over 20 years for two people.) If each of those meals costs five dollars, you'll spend $219,000 on food. Where is that money going to come from?

Most people don't know - or don't want to know. Of today's retirees, 51% have incomes below $10,000 a year. Also, the Social Security Administration defines financial independence as an annual income of $24,000 a year. Would you consider yourself financially independent if you earned just $2,000 a month? Another 30% of retired Americans earn $10,000 to $20,000 a year. That means only 19% of retirees earn more than $20,000 a year. The rest - 81% of all retired Americans - are financial failures.

It used to be that a worker and his family could be comfortable if he retired at 62 on a pension and Social Security. That doesn't happen anymore. Today, you don't retire as young as 62 - unless you've been downsized out of work. And you're going to live much longer than your parents and grandparents did, aren't you? Therefore, your money must last much longer. And that is the dilemma: If you fail to plan, you face the possibility of a retirement filled with poverty, welfare, and charity. A Gallup survey showed that 75% of workers want to retire before age 60, yet only 25% think they will. That suggests people don't know how they are going to achieve their goals. One thing is sure; it's not going to happen by itself. It's going to require effort and attention.

For many Americans, these are things they don't want to talk about. The biggest shock of their financial lives comes when they learn from a financial planner or a computer software program how much they ought to be saving each year for retirement.

The amounts can be so staggering that some people simply throw up their hands, figuring they will never be able to save anywhere near what's needed.

The good news is there's a simple way to figure out how much you'll need to retire on. First, you need to know how much you're spending today to maintain your lifestyle and then carry the numbers forward, adding a bit of inflation, to see what you'll need down the road. For example, if you are 40 and want to retire at 60, you have 20 years until retirement. Assuming you could live well on $50,000 annually, and plugging in a moderate three percent inflation rate, you'll need about $90,000 per year by the time you retire.

In general, the rule of thumb is having about 80 percent of your pre-retirement income to live on in retirement. But a better idea is to count on having 100 percent on hand. Inflation could go higher, Social Security may collapse, and you may live long enough where health care is a major, and expensive, issue.

The Advantages of Starting Early

They say life begins at 40. But saving for retirement should have started long before that - if you believe all those retirement planning books and articles. It's advice many people ignore. What if you're now in your 40s and you haven't even started?

The good news is you don't have to panic. But you do have to get serious about it - and you will face some tough choices. Making up for lost time could mean really cutting back on your current spending. If you don't start saving until your 40s, you'll need to set aside 20% of your gross income. If you wait until your 50s, your target will have to be 30%. As a last resort, you may have to sell your house, your cottage and your second car; get a second job; and reduce your leisure spending.

Take more risk. That doesn't mean putting all your money into penny stocks. But it does mean having a greater percentage of your investments in higher-earning equities rather than the more cautious Treasury and savings bonds that many people select as they get older.

Consider these examples:

If you start investing $100 a month at age 25 into a retirement account that gains 10 percent a year, by age 65 you'll have $632,000. But if you don't start investing the same amount until you're 35, you'll only take away $226,000 when you retire. Starting at 25 will get you $406,000 more, at a cost of only $12,000.

If you set aside $200 a month at a 10.2 percent return, you could start investing at age 21 and stop 10 years later and have a $1 million nest egg at age 65. That means a $22,000 investment over one decade gets you $1 million down the road. Of course, assuming continued inflation, $1 million then won't buy you what $1 million would today. But it'll buy you a heck of a lot more than nothing will.

The Rule of 72

Here's a trick some financial planners use. To find out how many years it will take your investment to double, divide the annual rate of return by 72. So at a 7 percent return, your money will double in 10 years and quadruple in 20 years. Financial gurus call it "the rule of 72."

The benefits of investing early in life are obvious. But to make it work, you also need to invest regularly. Saving at scheduled intervals in regular amounts has become easier, in part due to defined-contribution retirement options such as 401(k) plans. These are good start-up investments because money is automatically deducted from your paycheck and contributions are often matched by your employer.

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