- More than half of people over 45 aren’t prepared for retirement – there’s still time to get back on track and it’s critical to create a plan today
- People start late or fall behind for different reasons – knowing what kept you from saving allows you to create a plan to move past it and get back on track
- Defining your retirement is critical to knowing how much income you will need, how much you are on track to have, and calculating your income gap
- A well-defined financial plan is essential to closing the gap – you’ll see your options and trade-offs, make smart decisions, and avoid costly mistakes
- The clock is ticking and acting now is critical – if you aren’t sure how to get started, seeking professional help may be the one thing that changes your life
Being behind on your retirement savings can create feelings of stress, anxiety, and worry. Even thinking about how to get back on track can feel overwhelming and confusing. But with retirement on the horizon, using the time you do have to your advantage can make a huge difference.
Here’s what you can do now, and how a well-defined and evolving financial plan is the key to putting you in control of your future.
To get back on track, determine what knocked you off
Nearly two-thirds of non-retirees say that their retirement savings are not on track, and their reasons for falling behind are all different. Understanding what hindered your saving can help you be mindful of and potentially avoid the same mistakes in the future.
Here are four common reasons people fall behind on their savings:
- The obvious reasons: Raising a family, everyday expenses, or too much debt.
- The less obvious reasons: Unforeseen emergencies, job losses, or parents needing a little help.
- The planning reasons: Not knowing how or where to start, how much to save, or how to invest.
- The psychological reasons: Money is a difficult and emotional topic to address, so we tend to avoid it.
Different reasons require different solutions, and the right plan starts with identifying what held you back. Once you know your reason(s), determine if the issue(s) will continue. Are they a thing of the past? If so, be mindful not to let them creep back in. If not, be sure to incorporate them into your strategy.
Taking a look back can help you move forward. And moving forward requires that you get clarity on what retirement means to you.
Defining retirement and your retirement income shortfall
The hardest part about retirement, and creating a plan for it, is understanding what your retirement will look like and how much it will cost. Here’s how you can do both:
Define your retirement - Getting a better sense of your retirement goals can make the difference between feeling confident and stress-free or worried and anxious. Ask yourself these questions:
- Where do you see yourself living and what lifestyle do you want?
- What do you enjoy doing and how do you want to spend your time?
- Do you plan to work part-time, volunteer, or maybe even start a business?
- What is your family health history and are there specific issues to plan for?
- How long do you need your money to last and are you confident it will?
You don’t need to know all of the answers, but you should start working on them to make sure the planning you do has you headed in the right direction.
Calculate your retirement income gap - Estimate how much income you’ll need for your lifestyle and healthcare costs. Next, identify your retirement income sources, such as part-time work, Social Security, pension, and investment income. Once you know the gap between your income needs and your income sources, you can build a plan to bridge that gap.
Here’s an example to help you work through this on your own:
Step 1 - Determine your income today: Let’s say you need $80,000, before taxes, to cover your expenses today, and you are going to retire in ten years.
Step 2 - Adjust for inflation: That $80,000 will be more like $100,000 in ten years due to inflation. You can run different numbers here.
Step 3 - Determine your retirement income: Let’s say when you retire you will have $40,000 per year in Social Security income plus you have saved $500,000 for retirement. That $500,000 can generate about $20,000 per year in additional income for a total of $60,000 of retirement income.
Step 4 - Calculate the gap: So you need $100,000 of income and already have $60,000. Your income gap, or shortfall, is $40,000. This is the number you need to plan for by saving more or lowering your expenses.
Two additional considerations: First, your Social Security benefits will vary from the example, and you may want to consider the uncertainty of benefits in the future. Second, taxes can materially affect your outcomes so be sure to plan for your tax situation.
Source: Bureau of Labor Statistics. Assumes a 4% withdrawal rate. Does not factor in fees or taxes.
Don’t focus on the perfect number as it will likely change over time. However, you need to know your Social Security benefits at various retirement ages and how taxes will affect your investments and your retirement income.
With your income gap calculated, it’s time to create a plan to bridge it.
Financial planning is the key to making critical decisions
Financial planning helps you get organized, see the bigger picture, understand all of your options and associated trade-offs, and make the best decisions for your situation. At this stage, your choices can make, or break, your retirement.
Here are the critical planning decisions you need to consider:
- Spend less: Spending less reduces your income needs in retirement and increases what you can save today. Take a look at your expenses to determine where you can make adjustments. There are smaller changes – like cutting unnecessary expenses – or larger ones – like downsizing your home or moving to a retirement-friendly state with lower costs of living or taxes.
Let’s look at an example:
Let’s say you have ten years until retirement. If you cut your expenses by $500 per month ($6,000 per year) and invest that money for ten years at a 7% rate of return, you could have just over $80,000. Now you have an extra $80,000 and you cut your income needs by $6,000 per year.
Think about what changes you can make, how much it would allow you to save, and what that could mean for your retirement savings. You can run different scenarios here.
Keep in mind that taxes will affect the growth of your money and how much of it you keep when you use it to generate income in retirement. Your plan for taxes can materially change your outcomes.
Investment returns are not guaranteed. Does not factor in fees or taxes. Assumes a 4% withdrawal rate from your investments.
- Decrease and aim to eliminate debt: Start with consumer debt – credit cards, car loans, student loans – and then consider paying off your mortgage (if you have one) to reduce your monthly expenses.
- Save more: Take advantage of catch-up contributions in your retirement plans. If you’re over 50, you can contribute up to $27,000 to your 401(k) for 2022. IRA contributions also increase from $6,000 to $7,000 per year.
- Earn more: Changing jobs, starting a business, or picking up a side hustle could provide an opportunity to earn more income. Any extra income at this stage can supercharge your savings.
- Work longer: Delaying or phasing in retirement gives you more time to save, increases your Social Security benefits (they increase by roughly 8% per year after your full retirement age), and decreases how long your money needs to last.
Let’s look at an example:
If you were born in 1960 or later and delay taking your Social Security benefits until you are 70, your new benefit will be 124% of what it would have been at age 67.
So if your monthly benefit was $2,000 per month at age 67, your new benefit at age 70 would be $2,480 per month. That’s almost $6,000 per year of additional income for life. And keep in mind that your Social Security benefits increase every year based on inflation so that number only grows over time.
Source: Social Security Administration
- Plan for taxes: Look at contributing to different types of accounts like a 401(k), Roth IRA, taxable investment account, and even a health savings account (HSA). You’ll have more options to reduce taxes when you start making withdrawals.
- Reassess investments for risk: Reassess your strategy to make sure you have the right mix of stocks and bonds. And always remain diversified. Chasing big returns can expose you to unnecessary risks and big losses.
The best investment you can make in your future - professional advice
Making informed financial decisions can be challenging and overwhelming, especially when you are approaching retirement and feel behind. A personalized, ongoing financial plan can help you navigate your options with clarity and confidence. It may seem like a long, winding road, but you don’t have to go it alone. A CFP® Professional can help you create an ongoing financial plan to ease financial worry and stress and put you on a path to living the life you want and deserve in retirement.