the second year, assuming inflation is 4%, and so on. “That withdrawal rate, in addition to Social Security benefits, should be enough for me,” says Pearson. “If your lifestyle is not overly expensive and your home is paid for, you should be able to live comfortably on that much income.”
With those assumptions, retirement planning becomes a step-by-step process:
1. Determine how much you’ll need to maintain your lifestyle in retirement. Will you spend as much then as you do now? Will you spend more? Less? Several helpful budgeting calculators are available online at blackenterprise.com.
2. Estimate your retirement income from Social Security, a pension, and other sources. The annual statement you receive from the Social Security Administration can help. For a rough estimate of your benefits, use the Social Security quick calculator at www.ssa.gov. “For most employees, Social Security can be counted on to provide no more than 20% to 30% of a working paycheck,” says Steve Cooper, a principal at Nemco Brokerage Inc., an insurance broker in New York City. “If you earn more than $100,000 a year, your Social Security benefits will [constitute] an even smaller percentage of your income.”
3. The difference between the amount of your projected expenses and income is the amount you’ll need from your portfolio. Multiply this amount by 20 to get the target size of your portfolio, assuming a 5% initial withdrawal.
For example, assume your retirement spending goal is $85,000 a year and you expect to receive $20,000 from Social Security. You’d need to withdraw $65,000 from your portfolio each year, so you’d aim for a nest egg of $1.3 million ($65,000 times 20).
So how do you save $1.3 million, or $1 million, or whatever you might need? According to Cooper, saving through an employer-sponsored retirement plan such as a 401(k) should be your first choice. “When you save through your 401(k),” he says, “you save on a pre-tax basis, with 100-cent dollars, rather than the 60-cent or 70-cent dollars you take home each pay period.”
Moreover, you should start as early as possible. “If you wait until the peak of your career4your 40s or 50s4you’ll have to put aside more money to catch up,” says Genevia Gee Fulbright, a certified public accountant in Durham, North Carolina. “On the other hand, you can start putting aside much smaller amounts in your 20s and benefit from a longer time available for the funds to accumulate.”
Sophie Beckmann, a financial planning specialist with A.G. Edwards in St. Louis, offers the example of a 25-year-old who puts $3,600 into a 401(k) account. If the same $3,600 is invested each year and the annualized return is 7%, by age 65 the account will hold nearly $720,000. By comparison, someone starting at age 40 and investing that same $3,600 per year would have only $225,000 by age 65. The 15-year head start, during which $54,000 is contributed, generates nearly $500,000 in additional retirement funds.
Starting early may have another advantage if you work for an employer that not only offers a 401(k)