Individual Retirement Accounts are the go-to choice for US residents who are saving for their retirement pot, thanks to their mix of tax incentives and the potential for investment returns on your retirement savings.
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Many of you may already have an IRA or 401(k) in place but the thought of how much you need when you retire was probably not at the forefront of your decision-making process. As you approach retirement age, you may start asking yourself: how much is enough to have a “good” pension pot?
No doubt you want to be sure you’ll have enough money to live the kind of life you want, but your retirement saving plan also needs to ensure that your pension pot will last for the whole of your retirement.
The trouble is, it’s difficult to work out how much pension income you’ll actually need to retire and live comfortably. The answer to this question is as varied as you are: circumstances such as your current situation, your plans when you retire, and even things such as your health, what part of the country you are based in, and so on.
How much pension do I need?
For US residents looking to retire, one way to look at how much you’ll need when you stop working is to examine the amount of retirement expenses you’ll need in retirement.
Assuming your mortgage and other debts are paid off, you’ll need around 20 – 25 times your retirement expenses.
For example, let’s say that you spend an average of $20,000 per year in expenses, this means that you’ll need $400,000 – $500,000 in a pension pot. This could also include other investments, savings, and rental income.
Whilst these figures may seem daunting, they are at least realistic and certainly more attainable for most than the findings of a new survey which revealed that Americans believe they’ll need savings of $1.25 million to ensure a comfortable retirement.
The same study revealed, rather worryingly, that the average US retirement account holds assets worse less than $87,000.
Let’s put aside these hypotheticals and look at the question realistically. Your retirement goals should determine the size of your savings you will need in order to retire, rather than the other way around. In turn, this will decide how much you’ll need in pension savings.
What kind of retirement lifestyle do you want?
Ask yourself: what exactly do you want out of your retirement? What are your goals for when you reach retirement age?
An early retirement
You may have always wanted to retire early compared to the standard retirement age, making the most of your years after work.
Of course, to take early retirement, your funds will have to be able to support this extra period of time when you’re no longer working.
An expensive retirement
You may have always wanted to indulge yourself in your retirement, whether it’s the thought of going on long cruises and exploring the world, or maybe fully committing to your hobbies.
If your retirement goals are something along these lines then you’ll need to make sure your pension pot can provide you with the level of income you’ll need.
A “comfortable” retirement
Or maybe you just want to take it easy when you retire, and your goals are to spend time being with your family and friends and living more or less the same way as you do now.
You may go on a few holidays a year, or perhaps treat yourself to a new car, but otherwise, you’re content with simply having enough to live comfortably.
To live this kind of retirement, you’ll need slightly less in your pension pot compared to one of the more expensive strategies.
Your retirement will be personal to you, your family, and your goals
This list is far from exhaustive, but as a general rule of thumb, most individuals plan their retirement based on one of the above goals.
No matter what your goals are, it’s the lifestyle you want that will determine how much income you’ll need when you retire. Establishing your wants and needs will help you calculate the size of your pension pot, and more importantly help you save for the future and avoid the dreaded retirement gap.
How will you save towards your target retirement pot?
Once you have an idea of what kind of retirement lifestyle you want, you can start looking at how far your pension plan currently goes in achieving your goals.
Through a workplace 401(k)
If you’ve ever been employed, your employer will likely have offered you a 401(k) plan, or maybe a 403(b) though these are less common.
Your workplace scheme will be invested on your behalf by a 401(k) fiduciary, meaning the value of your pot has the potential to rise over time.
A 401(k) is what is known as a defined contribution plan, in this scheme any money you or your employer may contribute to the pot is invested pre-tax. Usually, the funds are then invested in capital markets where they can grow, and any earnings, they make are tax-deferred until such time as you retire and make withdrawals.
Defined benefit plans, are an outlier in the US and are very rarely offered by employers. The reason for their scarcity is primarily due to the fact that in a defined benefit plan the employee is guaranteed a set amount of money upon retirement, aka the defined benefit. If the retirement portfolio fails to perform at the level expected of it the employer is obligated to cover any shortfalls in order to ensure the employee receives the payments at the level agreed upon.
Individual Retirement Account (IRA)
The IRA is the most common retirement product offered in the US.
An IRA is an individual retirement account and is a way of saving for your retirement available to individuals who may not have access to a 401(k). Opening and setting up an IRA is easy to do as most brokers offer a strong mix of IRA plans, including major companies such as Vanguard, Charles Schwab as well as innovators such as Interactive Brokers and Robinhood.
Any money you invest into your IRA is then invested in a variety of securities, such as stocks, bonds, and mutual funds. Best of all IRA accounts come with tax incentives, which let you either defer tax on contributions made or make tax-exempt withdrawals upon retiring depending on whether you have a traditional or Roth IRA account.
When you’re working out how much you’ll need to retire, don’t forget to include the money you’ll receive from your Social Security.
Social Security is not exactly a retirement fund, as the money in this fund is usually not enough to provide a comfortable standard of living for retirees, but the money you receive should not be overlooked or forgotten about when planning your retirement.
Social Security is handled by the federal government and is funded through payroll taxes collected from employees and companies.
When will you receive Social Security payments?
The payments you are entitled to under Social Security are paid out upon the individual reaching the age of 62.
What is the size of Social Security payments?
The exact amount will vary depending on the age at which you begin receiving benefits as well as how many years you worked and the size of your contributions.
Which of these options will be right for me?
Your personal circumstances and goals will determine which of these options is best for you.
In all likelihood, your retirement income will come from a range of sources, including:
- Workplace pensions from one or more employers
- IRAs you have set up yourself
- Social Security
- Any other savings or investments you have
- Employment – you may decide to continue working part-time or on a consultancy basis when you retire.
Working out how much you need to save in pension contributions
Once you know what you want to achieve and how you plan to get there, you can start looking specifically at how big your pension fund will need to be.
How big is the average US pension pot?
As mentioned earlier the average size of a retirement account in the US stands at $87,000.
Assuming a retirement age of 67 and factoring in the average life expectancy of 77 in the US, that works out at about $8,700 per year in pension income.
If you plan on living a fairly modest lifestyle in retirement, this might be enough to support you.
But, if you’re targeting a more expensive lifestyle, this is probably not going to be enough.
The 10% rule
One figure that’s often bandied about is the idea of saving 10% of your earnings into your pension pot.
However, it’s likely that this amount will not be enough for most people. Sure, it helps to have a simple guideline to start saving and to motivate but the reality is that most brokers advise that if you want to achieve a “comfortable” retirement, you may need to be saving as much as 24% into your pension pot. And even if you start saving in your 20s brokers such as Fidelity Investments advise you to save 15% of your gross salary and continue throughout the course of your working life.
Saving half your age
Another popular strategy is to save an equivalent percentage to half your age.
So, for example, you should be saving 12% of your income into your pension pot aged 24. This should then rise to 15% aged 30, and so on.
This method means you start saving money earlier than you might have otherwise, giving your pension savings more time to make the most of potential investment growth.
Significantly, this figure obviously rises as you get older. This ensures you save even more of your money, meaning you’ll save the most money as you reach your greatest earning potential.
So, by the time you come to retire, you should have built up a good pension pot.
Use a pension calculator
Realistically, as your goals will determine how much you need, how much a “good” pension pot is will be specific to you.
If you want a quick way to work out how much income you need to retire, you could use an online pension calculator.
These tools allow you to input all your income and outgoings, working out what your income will be.
It then gives you a clear, visual image of how much pension income you’ll likely need to retire, allowing you to create a retirement plan that will help you reach your goals.
Taking financial advice
If you’re unsure how big your pot is going to need to be, you may want to take personalized pension advice from an independent pension adviser.
Independent financial advisers can provide you with personal pension advice for how much you’ll need to retire.
They’ll be able to use cashflow modeling to give you an accurate calculation of how much pension income you’ll need to live the lifestyle you want, alongside the rest of your money and assets.
By working with an independent financial adviser, you can have the confidence that you’ll have enough to live on in your retirement.
Their impartial advice will include a retirement plan that will tell you how much you need to pay into your pension now so that you have enough income later when you retire.
Make sure you choose a qualified advisor who’s authorized and regulated by the Securities and Exchange Commission (SEC) or by a state authority.