It's almost Thanksgiving and retailers are going all out on advertising this year. Plus, 2013 has a shortened shopping season because Thanksgiving is later than usual. As a result, retailers are opening even earlier on Thursday. For example, Kmart will open at 6 a.m. on Thanksgiving and will stay open for 41 hours for Black Friday. That's partly our fault because every year more Americans go shopping on Thanksgiving Day. The consumerist lifestyle may help the economy, but it won't help your retirement.
It's hard for young people to think about retirement because it's such a long way off. Getting a new 50-inch LCD TV takes just a few minutes with a swipe of the credit card. Black Friday makes it even more fun because everyone is out trying to score a good deal. It's easy to get caught up in the consumerist lifestyle and ignore the chore of saving for retirement. It's much harder to take the long view and see why spending less money is better in the long run. Here's why it's better to save that $500 instead of getting a new TV:
Less consumerism means you will need less money for retirement. Financial experts recommend replacing 70 to 80 percent of your income before you retire, which means the average household needs this proportion of their current income for retirement. This income can be from investments, pensions, Social Security or even a part-time job. As you can imagine, it's very difficult for most people to generate 70 to 80 percent of their current income without a job. That's why many people have to wait for Social Security benefits or a pension to kick in before they can retire.
Most people will need to spend 70 to 80 percent of their current income to get by in retirement. You don't have to be average, though. If you spend less and save more, then you will be used to it and probably won't need to spend a lot of money after retirement. %VIRTUAL-article-sponsoredlinks%What if you only spend 50 percent of your current income? Then you would only really need to replace half of your current income in retirement. It is much easier to achieve 50 percent replacement income than 80 percent.
Less consumerism means you can save and invest more. Another rule of thumb is to save 10 percent of your income for retirement. Saving 10 percent every year will most likely enable you to retire at 65 and generate the previously mentioned 70 to 80 percent replacement income. Many families spend all their income and even saving 10 percent is difficult. However, if you can manage to spend only 50 percent of your take home income, then you will be able to save a lot more than most people.
Saving and investing 50 percent of your take home income will put you on the fast track to financial independence. In 20 years, your investment income will likely be more than your earned income, and that's what being wealthy is all about.
Picture $500 compounded over 20 years. What if you saved and invested $500 instead of spending it on a new TV? After 20 years, you'll have $2,330 (assuming 8 percent annual gains). That's not bad, but not a life-changing amount either. However, once you start saving, it can become a habit. If you save and invest $500 every year, then you'll have $24,711 after 20 years. Now that's a more significant sum.
Saving 50 percent of income isn't possible for everyone. Saving and investing $500 per year will compound to almost $25,000 in 20 years. Imagine how much you'll have if you save 50 percent of your income. It will most likely be enough for you to achieve financial independence and do whatever you want. Of course, saving 50 percent isn't possible for everyone, but I think most of us can save much more than we are currently doing now. Let's examine our consumerist lifestyle and see if it's possible to cut back a bit and take the long view instead.
Joe Udo blogs at Retire By 40 where he writes about passive income, frugal living, retirement investing and the challenges of early retirement. He recently left his corporate job to be a stay at home dad and blogger and is having the time of his life.
For the best chance of maintaining your lifestyle in retirement, aim to contribute 15% of your salary, including any employer match, to your 401(k) or other savings account throughout your career (see What's Your Retirement Number?). Most people fall short of that benchmark. The average employee contribution to a 401(k) is 6% to 8%.
Saving 15% may seem like lifting weights at the gym for several hours. Try it anyway, says Stuart Ritter, a financial planner and vice-president of T. Rowe Price Investment Services. "Kick your contribution level up to 15% for three months. At the end of the three months, you can lower it, if necessary." But rather than dipping back to single digits, go with 10% or 12%, he says. "People find they can settle on a much higher amount than they were contributing before."
Procrastination is another risk: With each year you neglect to save, you lose an opportunity to fuel your accounts and to let compounding keep the momentum going.
So powerful is the effect of saving early that you could have less trouble catching up if you take a several-year break-say, to pay for college-than if you wait until midlife to start. At that point, says George Middleton, a financial adviser in Vancouver, Wash., "the amount of money you have to put away can be ungodly."
Still, you can make headway, especially if your kids are grown and you have fewer expenses. Say you're 55, earn $80,000 a year and have nothing saved for retirement. You put the pedal to the metal by setting aside $23,000 in your 401(k) each year for the next ten years. That $23,000 combines the annual maximum for people younger than 50 ($17,500 in 2013) plus the annual catch-up amount for people 50 and older ($5,500). If your employer matches 3% on the first 6% of pay and your investments earn an annualized 7%, you'd amass $434,700 by the time you reached 65.
For some investors, a bad case of the jitters became a bigger derailer than the recession itself (see How to Learn to Love [Stocks] Again). "People got very nervous and became more conservative, so when the market came back up, they had less of their portfolio participating in the rally," says Suzanna de Baca, vice-president of wealth strategies at Ameriprise Financial.
You can get back in (and stay in) by investing in stocks or stock mutual funds in set amounts on a regular basis. Using this strategy, known as dollar-cost averaging, you automatically buy more shares at lower prices and fewer shares at higher prices-an antidote to market-driven decisions. Once you decide on your mix of investments, use automatic rebalancing to keep it that way, advises Debbie Grose, of Lighthouse Financial Planning, in Folsom, Cal.
Most financial planners recommend that your portfolio be at least 80% in stocks in your twenties, gradually shifting to, say, 50% stocks and 50% fixed-income investments as you approach retirement. But formulas don't cure panic attacks. "Set your risk at the level you're willing to withstand in a downturn," says Middleton.
Amassing hundreds of thousands of dollars for retirement is challenge enough, but parents are also expected to save $80,000 to $100,000 per kid to cover the college bills. In fact, half of parents don't save for college at all, and the average savings among those who do runs about $12,000, according to a 2013 report by Sallie Mae, the financial services institution. Faced with a shortfall, two-thirds of families say they would use their retirement savings to pay for their children's college education, if necessary.
Don't wait until your kid is 17 to discuss how much you'll contribute. Have a conversation early about how much you can afford to give, says Fred Amrein, a registered financial adviser in Wynnewood, Pa.
A Roth IRA can be one way to save for both college and retirement, although it won't get you all the way to either goal. You can contribute up to $5,500 a year ($6,500 if you're 50 or older) in after-tax dollars, and the money grows tax-free. You can withdraw your contributions for any reason, including college, without owing tax on the distribution. You will pay taxes on the earnings (unless you're 59 1/2 or older and have had the account for at least five calendar years), but you won't have to pay a 10% early-withdrawal penalty if you use the money for qualified higher-education expenses.
Leaving the workforce, even temporarily, deprives you of current income and makes it tougher than ever to save for retirement. You might even find yourself tapping your retirement accounts to cover day-to-day expenses. You'll owe taxes on distributions from a traditional IRA plus a 10% penalty if you're younger than 59 1/2.
The best way to avoid that dismal situation is to have an emergency reserve that covers at least six months or even a year of living expenses, says Jim Holtzman, a certified financial planner in Pittsburgh. He acknowledges, however, that "that's easy to recommend and hard to implement." Avoid further disaster by hanging on to health insurance: If you can't get coverage through your spouse, look into keeping your employer-based coverage through COBRA. You can extend that coverage for up to 18 months, although you'll pay the full premium plus a small administrative fee. As of January 2014, you'll also have access to coverage through state health exchanges.
Married couples who depend on each other's earning power need life insurance to cover the gaps when one spouse dies. You can get a rough idea of how much coverage you'll need on each life by calculating what you each contribute to annual living expenses and multiplying that amount by the number of years you expect to need it, says Steve Vernon, of Rest-of-Life Communications, a retirement consulting firm. (For advice on how to do a more precise calculation, see How Much Life Insurance Do You Need?)
If you have a pension, you'll have the option of choosing a single-life benefit, which ends at your death, or the standard joint and survivor's benefit, which pays less while you're alive but keeps paying (typically at 50% to 75% of the benefit) for the rest of your spouse's life. Your spouse is legally entitled to the survivor's benefit and must sign a waiver to forgo it. Don't be tempted by the higher-paying single-life option if your spouse will need the survivor's benefit later.
Decisions you make in claiming Social Security are similarly key. If you're the higher earner (typically, the man), "you will really help your spouse by delaying Social Security as long as possible," says Vernon. The benefit grows by about 6.5% to 8% a year for each year you delay after age 62, when you first qualify, until you reach age 70. If you die first, your spouse can qualify for a survivor's benefit up to the full amount you were entitled to, depending on the age at which she files.