I have read literally thousands of articles about retirement planning. Indeed, I was responsible for developing and writing retirement plan communications for years. I’ve seen the reports of people not saving, not saving enough, having too much debt, etc. And I’ve seen the solutions – budget, figure out how much you’ll need in retirement, and don’t leave free money on table. But it all came to a head recently when I started thinking about how I would advise my soon-to-be college graduate to invest for retirement.
Think back to when you started your first job. You were thrilled someone wanted to hire you. Maybe you were excited about moving to a big city or away to a foreign land. You were nervous – can I do it, will I be successful? The last thing you were considering was how much you would need in retirement.
And there’s nothing wrong with that. Even for people in their 40s, a prediction on how much they will need in retirement is only a best guess. Maybe you’ll need less, maybe you’ll need more. Maybe the markets will return 10%, maybe 2%. Imagine how mush harder making a prediction is for a 22-year-old.
Start saving today
Instead of trying to determine the perfect amount of money for retirement, a new worker should set a goal for contributions and not worry about what those contributions will total in 45 years. Of course, you can’t set your contributions at 1% of your salary and put it into a savings account (earning another 1%). You’ll never get anywhere. But a new hire should start by putting enough into their company retirement plan to get all of the matching money. Many plans have a 50¢ on the dollar match up to 6%, so that if you contribute 6% they will add in 3%.
Starting today is key. I’ve mentioned it before, but the earlier you can start saving, the more money you could have due to compound interest. Even with a smaller salary, you have an advantage over others: youth. Don’t waste it.
Use raises to increase your percentage
Quite honestly, 6% probably won’t get you where you want to be in retirement either, even with the company match added in. Many financial experts suggest you save from 10% to 20% of your pre-tax income into a retirement plan, whether through work 401k plans or IRA/Roth IRA accounts (or all of the above). If you can start at 10%, pat yourself on the back, but consider contributing a few more percentage points every time you get a raise until you’re closer to 15%.
Invest automatically
When you decide to invest, make it automatic. If you’re contributing to a company retirement plan, all you have to do is tell your HR department the amount you want to contribute and it will come straight out of your paycheck. When you ready to invest more, it’s an easy email to get the right form and you’re all set.
Even if you don’t have a company retirement plan, you still want to pay yourself first. That means you should meet with HR to set up an automatic withdrawal that comes out of each paycheck and is sent to your IRA/Roth IRA account.
Don’t forget other saving goals
There are obviously other money goals you’ll need to save for: your emergency fund, a trip to Paris, a home, new cars, children. The list goes on and on. But make sure that trip to Paris doesn’t preclude your retirement or emergency fund savings.
Watch out for promises
Many retirement plan websites have started providing projections of where you’ll be at retirement if you continue contributing at the rate you currently are. Be wary of these. One example I read stated the following: the retirement projection “is not based upon your current asset allocation. The current … balance is projected to grow until retirement according to the following assumptions: the 12-month average of your total employer and personal contributions shown in the chart, each projected to grow 3% annually reflecting assumed inflation increases, as well as a non-guaranteed hypothetical annual asset growth rate of 6% until age 65.” You may see a projection that you’ll have millions when you retire so why save more? However, that projection isn’t based on what you’re doing, it’s based on what you might do. Seemingly, the further away from retirement you are, the more this number could be a fantasy.
Determine needs when you’re a little closer to the goal
At some point, you will want to take a closer look at what you might need at retirement. This point will be different for each person. Some will still try to guess at 22 if they will want to travel the world or have a small farm when they retire. Will they receive an inheritance or be paying for three generations to live together?
Consider taking a close look no later than your 40th birthday. When you’re 40, you have usually accomplished more of life’s goals and your career path is more defined. This doesn’t mean start contributing at 40 – you should have been contributing steadily into a retirement plan since your first job.
Take a look at what you’re spending. This won’t match dollar-for-dollar the budget you will need for retirement. Commuting costs, dry cleaning, professional dues, and the wear and tear on your car should be less when you retire. However, health care, travel, and social activities may go up. But it should give you a starting point to say “I need xx dollars to be comfortable.” Maybe it will also show you areas where you can spend less now and save even more.
Daydream about retirement. Where do you see yourself? Will you want to stay in your current town or state? Will you relocate to a retirement haven in Panama? You don’t need to make decisions now, but it’s good to at least consider your options.
Some people advise to look at the most expensive, extravagant lifestyle you’d want and the least expensive lifestyle you might choose. If – based on the growth and contribution projections for the next 20 years – you can afford the most extravagant lifestyle, congrats! You could keep the pace or increase your contributions to retire sooner. If you have more than enough, you might be tempted to decrease your contributions, but consider the ramifications. If the markets tank right before you get to retirement age and you dropped your contributions, you might be working for longer than you think. Maybe a better route would be to keep contributing at your current level until you’re 50, then reevaluate.
None of this means a young new hire can’t play around with retirement calculators and projections; it’s fun to daydream about retiring overseas. But the idea that someone fresh out of college would know what they want at retirement, or how much they might spend, is ludicrous.
Photo by Elijah O’Donnell