Retirement planning is getting a lot of news space these days because we all feared for the plight of the baby boomers. The personal debt crisis and the shaky economy left a lot of us struggling with all our financial obligations. Instead of being able to put aside money for our retirement, we had to prioritize debt payments instead. If not, the interest rate alone can bury you in so much debt that it would have been very hard to completely be rid of it.
Bankrate.com, based on the information they got from the Bureau of Economic Analysis, revealed that Americans are currently saving only 4 cents for every dollar that they earn. This is not even close to the ideal saving goal of 10%-15%. Apparently, this is not even half of what the people in the 1970s and 1980s were putting aside for retirement.
Obviously, we still need to take retirement planning a lot more seriously than what we are displaying. If you think about it, the longer you put it off, the more you will have to contribute in the future.
Four retirement rules when planning for your future
As you plan your retirement, there are a couple of rules that you need to follow. In this article, we’d like to focus on 4 different rules that are closely associated with saving for your future. All of these can help you do the confusing math when it comes to setting up your future to be financially secure. When it comes to retirement, you definitely want to avoid the common retirement planning mistakes that can make your funds fall short when you need them the most.
Multiply by 25 rule
This rule will help you determine how much money you need to target for retirement. One of the first steps when planning for your future is finding out the money that you will need to help build a comfortable retirement for yourself.
What you do is to simply get your expected annual income and multiply it by 25. For instance, if you expect to use up $45,000, you need around $1,125,000 by the time you reach your target retirement age.
You are probably wondering, why does it have to be 25? The reason for this is you need to take into consideration the inflation rate, high cost of living and the ridiculously high cost of medical treatment. Not only that, financial experts point out that you need to generate an estimated 4% annual real return on your savings. This is with the assumption that the stocks that you will invest into will produce an annual return of 7%.
4 percent rule
The next retirement planning rule is the 4% rule. This can be quite confusing especially when discussed together with the “multiply by 25 rule.” Both of them work on the assumption of a 4% annual return.
To differentiate them, you need to understand the purpose of each. The first rule guides you on how much you need to put aside to get your ideal annual income when you retire. The 4% rule will tell you how much you should withdraw from your retirement fund to make it last.
What you do is to compute the 4% of your retirement fund during your first year as a retiree. That amount will be your budget for the whole year. For instance, if you have $500,000 put aside, 4% of that fund is $20,000. You need to withdraw only this amount for that first year. The second year, you will withdraw the same amount plus the inflation rate. If the inflation rate is 3%, you will multiply $20,000 with 1.03. That means you are allowed to withdraw $20,600.
The multiply by 25 and the 4% rule are viewed by some financial experts to be too risky. The average inflation rate is 3% and they think that basing more than this can risk the money of the consumer. Given that, here are two more retirement planning rules that are on the conservative side.
Multiply by 33 rule
This is, obviously, the alternative to the multiply by 25 rule. Instead of getting your annual rate and multiplying it by 25, you will multiply it by 33. So following the example we set earlier, you will multiply $45,000 by 33 and your new retirement fund target will be $1,485,000.
3 percent rule
This is the more conservative approach to the 4% rule. Instead of withdrawing 4%, you will withdraw only 3%. So if you have $500,000, you will only withdraw $15,000 on the first year and the second year (being computed based on a 3% inflation rate) will allow you to withdraw $15,450.
To choose between them, you need to determine how confident you are about your future and the national economy too. If your confidence is not too great, then you need to take the more conservative approach of the multiply by 33 rule and the 3% rule. But if you are pretty confident that your investments will yield the expected returns, then go ahead and use the multiply by 25 rule and 4% rule.
How much do you really need to retire?
In truth, the confusing part in retirement planning is determining how much you really need to retire. There are just too many factors involved and most of them are based on assumptions and, sometimes, even your aspirations. When you are trying to determine a specific amount, basing them on estimates seems like a terrible idea. But given that you are trying to predict the future, this is really something that you cannot avoid.
However, that does not mean you need to make your estimates blindly. There are certain parameters that you can follow and it all involves two questions: what is happening in society and what do you want to have?
What is happening in society?
The first question is the reality that is happening in our society today. How is the national economy? Is the cost of living still within your expectations or has the inflation rate overrun your income? What is the prediction of survey and statistics about the period when you are about to retire? What is the current conditions of the present retirees?
These are all questions that will make you look at what is happening outside of your home. A bit of research and news searching is necessary here. You can start by looking at retirement statistics. For instance, StatisticBrain.com reveals that 35% of Americans who are currently retired are relying on their Social Security. And, the total cost of medical treatments for a couple is $215,000 (span of 20 years). Lastly, 80% of the people between the ages of 30-54 admit to not having enough money for their retirement.
This paints a picture of poor retirement planning. If you are faced with this statistic, you need to start preparing health insurance to cope with the medical costs. You also have to start boosting your contributions if you are one of those who think that they will not have enough to retire.
What do you want to have?
The next question that you need to ask yourself is what type of life do you want to have in your retirement. You need to look at the factors that you can personally control, or is revolving around your present conditions. A good way to start is to determine your expected retirement expenses. Here are some starter tips for your retirement planning:
Determine where you want to live. Your home will still be the biggest expense that you will have. Downgrading would really be a good idea at this point. It will keep you from paying a lot on your utilities.
Know your current health condition. Medical expenses is another big expense for retired individuals. If you want to enjoy a long retirement, make sure that your health is in tiptop shape. It is also wise to look at any health issues in your family – that should help in anticipating any medical problems you may have in the future.
Decide what you want to do during your free time. One thing that retirees will definitely have is a lot of time in their hands. Do you plan to pursue a hobby? If so, you have to compute how much that will cost you. Or, will you plan on working part time? This will help you determine additional income apart from the one coming from your retirement fund.
Identify the benefits that you will get. This involves your Social Security benefits, pension, and other company sponsored retirement benefits that you have.
All of these will help you determine how much money you need to have. Retirement planning is not something that is set in stone so be prepared to make some changes along the way. Sometimes, the change will be for the better but do not rule out that it could also be for the worse.