If you’re like most Americans, a 401(k) or similar retirement plan represents the bulk of your long-term savings. Every year, the IRS places limits on the annual contributions you can complete to these and other qualified retirement plans. Too often, people mistakenly think that if they’re contributing these maximum annual amounts, they’re saving as much as they need. While these limits might be acceptable for some individuals, they may not be adequate for everyone. The reality is that the amount you need to save for retirement hinges upon the following five key factors.
Earnings
You might be surprised by the threshold of earnings at which you need to save more than the maximum contribution limits. Younger individuals typically need to begin saving more than the maximum allowed under their company retirement plan (currently $18,000 for most plans) once their earnings exceed $100,000.
As you get older, the level of savings will vary, largely dependent upon your savings history.
Existing Savings
The amount you’ve already accumulated or inherited plays a large role in determining the amount you need to save today. Hopefully, this amount is meaningful. If you’re age 40 or older, it should ideally represent multiple years of your annual salary.
However, if you were late to begin saving, or had an unfortunate financial or life event, the amount you need to save now could be much greater. It could easily exceed your employee retirement plan contribution limit, even taking into account permissible catch-up contributions for those aged 50 and older.
Pensions And Social Security Income
Most people are eligible to receive Social Security income benefits upon retirement, but few individuals are eligible for pension income. It’s important to review your benefit statements and evaluate the value of future income benefits relative to your income needs.
The more you earn, the chances are the more you’ll need to supplement your projected benefit entitlements. This is particularly true with regard to Social Security benefits, which only replaces a portion of your income. Furthermore, your contributions into Social Security cap out above an annual income limit, currently $127,200. People earning less than this threshold need to save to supplement Social Security, and those earning more than the threshold need to save even more aggressively.
Expenses
A long standing retirement myth is that expenses decline in retirement, but the reality for most Americans is that expenses stay the same or even go up , as you find ways to occupy your current working hours, outsource more tasks as you age, fund increased medical costs, and so on. When it comes to figuring out cash flow, we often recommend a straightforward approach that looks at incoming cash, the amount allocated to taxes, and what you succeeded in saving. The difference equals the amount you spent.
Taxes
One of the biggest oversights about qualified retirement plan savings is that they are fully taxable as ordinary income upon withdrawal. This ultimately dilutes their actual value.
When you have a large expense in retirement, like a new car or roof, the cost can balloon if you pay for it from a qualified retirement account. You’ll need to withdraw the amount you need, plus the amount you owe in taxes. The tax consequences can make a large expense astronomical. For that reason, we always advise clients to accumulate savings in both qualified retirement plans and traditional brokerage, investment and saving accounts (non-qualified accounts). Such non-qualified accounts don’t have the same punitive tax exposure when you need to take withdrawals, making it easier and cheaper to cover expenses in retirement.
While these five factors are essential in helping you to determine the amount you need to save today, your true retirement savings requirements are based upon a host of unique considerations, both financial and non-financial. SageVest Wealth Management prides itself in taking the time to work individually with every client to understand, guide and support you toward financial goals that align with your life. We invite you to contact us for more information.
