Planning for retirement takes discipline. Financial expert Mark Lamkin from Lamkin Wealth Management explains five costly setbacks that could change plans for retiring comfortably.
1. Starting too late
Procrastination is perhaps the largest risk in retirement. With each year you neglect to save, you lose an opportunity to fuel your accounts and to let compounding keep the momentum going. Say you're 25, you earn $40,000 a year and contribute 13% of your salary annually, including the company match. At that pace, you would accumulate a stash of almost $500,000 (in today's dollars) by age 65, according to an example by T. Rowe Price (the calculation assumes a 3% annual raise and a 7% annualized return, discounted by 3% annual inflation). If you wait until age 30 to start saving, you would have to set aside 17% of your salary annually to arrive at the same amount. The longer you wait, the higher the number becomes. Waiting to save and not saving enough when you do are two of the biggest risks of retirement planning.
So powerful is the effect of saving early that you could have less trouble catching up if you take a several-year break to pay for college-than if you wait until midlife to start.
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.
2. Shying away from stocks
Given the devastating bear market of 2007-09, it's no surprise that more than half of respondents in the Ameriprise survey said the downturn had negatively affected their retirement savings. But the resounding comeback since then means that most people who were in the market regained those assets if they didn't sell everything off and actually were ahead, if they continued to add during the market downturn.
That's a big if. For some investors, a bad case of the jitters became a bigger derailer than the recession itself. "People got very nervous and became more conservative, so when the market came back up, they had less of their port-folio participating in the rally," says Lamkin. Not only did they lose the potential for growth, but they stayed out too long. Time in the market often does better than timing…especially during the average correction or bear market.
If you're among those who bailed on the market and balked at reentry, 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 to buy, when stocks are high and sell in a panic at market lows. Once you decide on your mix of investments, use automatic rebalancing to keep it that way.
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 Lamkin. "If you freaked and sold out in 2008, you'll have to set the level very low so that you won't do it again."
3. Putting college first
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 financial services institution Sallie Mae. 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.
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.
4.Losing a spouse
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
5. Social Security taxes.
Most people realize that they are paying a tax into the Social Security system during their working years, but did you know that you may also have to pay tax on your benefits once you start receiving them? Up to 85% of Social Security benefits are taxable, and the income thresholds that trigger Social Security income taxation are low -- $32,000 for a married couple, for example (see Plan to Pay Taxes on Social Security).
You'll also forfeit some benefits if you continue to work before you hit full retirement age -- you give up $1 in benefits for every $2 you make over the annual earnings limit (for 2013, that limit is $15,120). The good news is that once you pass full retirement age, your benefit will be adjusted upward to account for the forfeited benefits. To learn more about the ins and outs of Social Security, check out our Special Report: Maximizing Social Security Benefits.
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