What Should I Be Saving: Part 3

This blog will continue the theme of how much you should be saving each year in order to meet the future goals that you have for yourself and your family.

In the previous blogs, I used an individual who was in the 20 to 30 age bracket and then an individual who was in the 30 to 40 age bracket. This blog will focus on the next decade of ages – the 40 to 50 age bracket. If you have waited until this time to start being serious about saving for the future, then you have lost about 20 years of your lifetime to build the wealth you want for your later years. Furthermore, you are about half way through your earnings years so you have about 20 years left to save and retire in your early to mid 60s.

For this blog, I am going to approach the question of saving from two perspectives. First, I will look at it as if you have saved nothing to date and then I will look at what would have to happen if you had saved something prior to reaching you 40s.

Again, I will assume that you are single and living on the one income you have. I will look at different income levels today and I will take out the impact of the various federal and state taxes that you pay since these will not be part of your lifestyle expenses when you reach retirement age in the future.

If you are earning about $20,000 today, you have about $16,600 to meet your expenses of housing, food, clothing, etc. Going forward, I will assume the 3% annual inflation for your income and for expenses. Your expectation may be that you will gain promotions and more education that will increase your pay faster than the 3% inflation, but I will not consider that in this section of the blog. I am also not considering any decreases in your income that might occur as you get older or should you happen to become unemployed for any period of your working career.

So let’s see what Social Security would provide as a benefit if your earnings were in this bracket today and increased each year until you reach retirement. In this scenario, your Social Security benefit would be about $16,092 annually if you retired at age 62. If you delayed the start of this benefit until your full retirement age (67), the benefit would increase to about $24,180 annually and to $30,924 if you waited until age 70 to start your Social Security benefits.

If your annual lifestyle expenses of $16,600 increased by 3% annually going forward, the annual cost to live at those various retirement ages would be about $32,000 at age 62 and $40,500 at age 70. So Social Security is going to meet between 50% and 75% of what you need to live a comparable lifestyle in retirement. The rest will have to come from what you save. If you saved $1,000 each year for the rest of your working career until you reach age 67, and you earned 7% annually all those years, your money would last you until about age 78. If you increased the savings rate to $2,000 each year, the money would last you until about age 91. If you made only 6% on your investments, they would run out at about age 83.

Let’s assume you have been a good saver in your earlier years and today you have $10,000 saved and you can save $1,000 per year going forward and earn 7% on all the money saved. That would add about 10 years to how long your money would last – age 88 rather than the age 78 in the previous paragraph.

Today you are doing better than the $20,000 wage earner in the above example. So let’s look at someone who is making $45,000 today. After taxes, you would have about $35,000 to cover your lifestyle, a little more than twice what the previous example had even though you are making 2 ¼ times that example on a gross income basis. Again this is because you have a higher tax bill to pay for that higher income.

Assuming the same assumptions as the first example for inflation, etc., you need to save $6000 each year and earn 8% annually in order to reach age 100 and live the same type of lifestyle that your $45,000 income provides today. At this income level, the Social Security benefit at age 67 will provide about 52% of your estimated living expenses and the balance will be from what you save.

If you save less than the $6,000 per year and earn less than that 8% return, your savings will run out sooner. At 6% return and $5,000 saved each year, the money runs out at about age 79.

Should you decide you want to retire at age 62 in this scenario, your Social Security benefit would cover only 40% of your lifestyle needs. This means you need to save more now or have a part-time job then in order to cover the shortfall.

Let’s assume you are one of those good savers and you have a nest egg today of $60,000 and you save $5,000 per year going forward and earn 6%. That extends your age at which money is exhausted to age 90 versus age 79 noted above.

Due to your ability to get promotions and the type of industry you work in, your pay is higher than the two previous examples. So what if you are earning about $71,000 per year today? You might be able to save $8,000 each year and earn that 8% return. In that case your money would get you to age 87 and your Social Security benefit at the full retirement age would cover about 46% of your lifestyle. If your return on investments was only 7% you would need to increase your annual savings rate to $9,000 and already have $60,000 saved in order to support your lifestyle until age 100.

If you wanted to retire at age 62 in any of these scenarios, obviously you would need to save more each year going forward in order to cover the lower Social Security benefit you would be receiving. At the other end of the spectrum, you could delay the start of your Social Security benefit until age 70 and receive a higher monthly benefit for the rest of your life. The challenge in this case is that you would have to work additional years at a level of pay that would cover your lifestyle or save more money each year going forward to be able to live off your savings to make up what is lost from not getting the Social Security benefit.

If you compared the numbers in this blog to the earlier blogs that were looking at your peers who are 10 or 20 years younger than you, you will see that the amount you have to save now is much higher than if you had started 10 or 20 years earlier. You may also realize that you need to make more money today if you want to have the same lifestyle as that younger person. This may mean that you need to work at a second job or volunteer for more overtime, if available, at your present job with the idea that the extra money goes to savings rather than being spent on current lifestyle items.

So what can you do today if you are older and have not started a consistent savings plan for your future goals:

1. First, review the ideas I provided in the earlier blogs because they apply to you as well.

2. Review what your lifestyle is and be sure that everything making up your lifestyle that takes money is as important as the goal of having a financially secure and comfortable lifestyle when you retire. A dollar saved today will be much more valuable to you when you retire.

3. When you are thinking of upgrading that house or car to a more expensive one, think seriously about the cost commitment you are making when that house or car payment is higher than what you are paying today. That higher amount could be what provides you with the more comfortable lifestyle in retirement by putting that amount into a retirement fund.

4. Review the investment goals you have. Be sure you are investing in appropriate assets for your risk tolerance and goals. While you want the safety of the principal side of what you have invested, appreciate the growth potential that can be there with slightly more aggressive investing in higher return investments.

5. If your employer is providing a match to what you put into the 401(k) or similar program, be sure you are getting that match by putting in what you need to put into the program. This is free money so do not miss getting it.

6. Be sure to follow what is happening with retirement savings legislation, Social Security rules, and your employer’s benefit programs as they relate to retirement issues. As these change, you may have to change how you are saving for your retirement.

In my three blogs on “What Should I Be Saving,” I have tried to provide ideas on how important it is to be saving throughout your working history. I hope I have gotten across the importance of saving earlier rather than later because it is very hard to save more later and catch up for the lost years of not saving. Saving earlier provides two very important things that you can not get back – the time value of money and the benefit of compounding.