Maintaining Standard of Living in Retirement
An obvious retirement planning question is "How much should I save for retirement?"
The simple answer is "enough to maintain your pre-retirement standard of living." This requires you to quantify
your current standard of living expenses and to project these into retirement.
An August, 2014 report from Newsmax.com quotes The Center for Retirement Research at Boston
College which says that currently 53% of households will not be able to maintain their standard of living in retirement.
According to the article this is due to four factors:
- Less than half (48.8%) of all private sector employees
worked for an employer sponsoring a retirement plan,
- With wages stagnating in recent years, many workers have been
unable to save for retirement,
- Home equity is no longer a reliable source of savings for retirement, due to a reduction
in home ownership and the drop in home values, and
- Social Security benefits will have declined 25% by 2030 as the
full retirement age rises and Medicare premiums continue to increase.
This information demonstrates the importance of starting to save early and regularly, maximizing
the years in which you work, knowing how much you'll need in retirement (according to your retirement budget), knowing
what you have (your net worth), and making the informed decisions regarding your savings and investments.
One’s ability to retire at a desired age with a comfortable lifestyle is primarily dependent upon
measures taken during wage-earning years. The earlier that retirement planning and savings begin the more likely that
you’ll be ready at retirement time. For example, a hundred dollars invested per month at age 35 will yield over
$100,000 at age 65 (assuming 6% annual interest), whereas waiting until age 45 to start this investment will yield less than
half the amount ($46,200).
One of the best ways to save for retirement is through tax-deferred savings accounts. These include
Individual Retirement Accounts (IRAs), employer-sponsored retirement plans [401(k), 403(b) and Section 457], and small business
retirement plans (Keogh, SEP and SIMPLE).
Contributions (money added) to employer retirement plans and
some IRAs can be made with pre-tax dollars (i.e., income you don’t have to pay tax on). Taxes on both the contributions
and investment returns are deferred until you start making withdrawals (after age 59 ½ without penalty). If your
employer doesn’t offer a retirement plan, or if you are maxed out on allowable pre-tax contributions to a 401(k) or
IRA, you can still contribute after-tax dollars to traditional IRAs (up to the allowed maximum), Roth IRAs (if your income
is not too high), Variable Annuities, and U.S. Treasury Securities. These instruments also allow your retirement investments
to grow tax-free while retaining the advantages of dividend reinvestment or interest compounding. You’ll then
have to pay taxes, except for Roth accounts, on the total amount withdrawn in retirement. Due to the substantial fees
associated with Variable Annuities and the relatively lower (although safer) return on U.S. Treasury Securities, these investments
should be in addition to 401(k) and IRA investments.
When contributions are made in pre-tax dollars [e.g., 401(k) plans], taxable income is reduced by the
amount invested, providing a tax savings and most likely increasing your ability to save more. For instance, if you
are in the 25% marginal income tax bracket and you contribute $1,000 to a tax-deferred retirement plan you would lower your
federal income taxes by $250 (0.25 times $1,000). The savings is based on your marginal tax rate, i.e., the rate you pay on
the highest dollar of earnings.