What Benchmarks Should You Consider?
Just as a fitness tracker can help you assess your progress toward fitness goals, having benchmarks can help you stay on track with your retirement savings. However, with so many benchmarks and rules of thumb, it can be tough to know which ones really apply to you. Whenever you encounter these “rules,” it can be helpful to take a look at the underlying assumptions. Does the calculation assume you’ll receive Social Security? That you’ll retire at age 62? That you’ll need a certain percentage of your annual salary in retirement? Once you know the assumptions, you can decide how they apply—or don’t apply—to your own situation.
How to Make Benchmarks Manageable
It’s estimated most people will need at least 8 times their final salary by age 67 to fund retirement at 85 percent of pre-retirement income. For example, a final salary of $100,000 would require $800,000 in savings. It may sound like a lot, but you can break it down into manageable chunks and adjust when necessary.
Benchmark #1: Have you already started saving in an employer-sponsored plan or IRA? If so, congratulations! You’re already on the right track. If not, don’t wait any longer. Getting started is the most critical hurdle, which makes the subsequent hurdles much easier to overcome.
Benchmark #2: Strive to save the equivalent of 1 year of salary by age 35. Take your current age and subtract it from 35. Divide your anticipated salary by the difference to see how much you should be saving each year. For example, suppose you’re 26 years old and expect to make $32,000 a year. Divide $32,000 by 9 years (35 minus 26). You need to save about $3,500 a year—or about $295 a month—to reach your goal.*
Benchmark #3: Rack up 3 times your salary by age 45. If you’re making $40,000 a year at this point, that would mean $120,000 should be in your retirement account.
Benchmark #4: Aim for 5 times your salary by age 55. Someone making $45,000 a year should have $225,000 saved.
Benchmark #5: If you’ve been staying on track, you should be able to save 8 times your final salary by age 67. For example, a final salary of $50,000 would require $400,000 in savings—$50,000 x 8 = $400,000.*
*Calculations are for illustration only and don’t take into account any potential raises or account earnings.
Are You On Track?
Use these tips to measure progress and make adjustments where necessary:
- Update your goals. Use the salary you're earning at each age to calculate the corresponding benchmark.
- Monitor your performance. Tracking your progress against milestones gives you insight into your savings progress.
- Rebalance and reallocate. If your goals, timeline or risk tolerance change, you may need to rebalance your retirement allocation by changing the mix of your investments.
- Rev up, roll over and pay down. Meanwhile, aim to increase your contributions by 1 percent each year. Remember—the difference between 1 percent and 2 percent of a $35,000 salary is only about $30 a month, less than a dinner out with friends. Consider this example:
A 30-year-old contributes 6 percent of a $35,000 salary in a tax-deferred account and gets a 3 percent raise each year. By age 67, he or she could accumulate:
Managing Loans and Withdrawals
Borrowing or withdrawing money from your retirement accounts may seem like an attractive option in the face of a financial hardship. Although there may be times when a loan or withdrawal from an IRA or 401(k) plan is your best or only option, you may want to explore other options before taking money from your retirement nest egg.
Many 401(k) plans let participants borrow from their accounts to buy homes, pay education or medical expenses, or prevent eviction or mortgage default. Generally, you may be allowed to borrow up to half your vested balance up to a maximum of $50,000 or less if you have other outstanding 401(k) loans.
Usually, loans must be repaid within 5 years, although the deadline may be extended if it's used to purchase your primary residence. Servicemembers may also get an extension during the time they’re on Active Duty.
Potential advantages of 401(k) loans:
- You won’t need a credit check. This may be particularly important if your credit score is less than optimal.
- Interest rates are generally low compared with most consumer loans.
- You’re paying yourself back—with interest—rather than paying someone else or a financial institution. This gives you an opportunity to build your 401(k) account back up, especially if you continue to make new contributions.
Potential drawbacks to 401(k) loans:
- If you leave your job, even involuntarily, you may have to pay off the loan immediately (usually within 30 to 90 days), or you'll owe income tax on the remainder, as well as a 10 percent early distribution penalty if you're under age 59½.
- You may not be able to afford to make the payments as well as make new contributions, thereby significantly reducing your potential long-term savings.
- While you’re borrowing pre-tax money, you’ll be paying it back with after-tax money, but will still owe taxes on withdrawals in retirement.
Withdrawals From 401(k) Plans and IRAs
Unlike a loan, a withdrawal isn’t expected to be repaid. Many 401(k) plans allow hardship withdrawals to pay for certain medical or higher-education expenses, funerals, buying or repairing your home, or fees to prevent eviction or foreclosure. You'll owe income tax on these types of withdrawals as well as the potential 10 percent penalty, and your contributions will be suspended.
Unlike employer plans, with traditional IRAs you're allowed to withdraw from this account at any time for any reason. However, you'll pay income tax on the withdrawal and often the 10 percent penalty as well, if you're under the age of 59½.
With Roth IRAs, you can withdraw contributions at any time, since they've already been taxed. However, if you withdraw earnings (withdrawals that exceed the amount of your original contributions) before age 59½, and you haven’t held the Roth for at least 5 years, you'll likely face that 10 percent penalty and owe taxes on the earnings.
Further Tax Implications
With 401(k) and traditional IRA withdrawals, the money is added to your taxable income, which could bump you into a higher tax bracket or even jeopardize certain tax credits, deductions and exemptions tied to your adjusted gross income (AGI). All told, you could end up paying half or more of your withdrawal in taxes, penalties and lost or reduced tax benefits.
Losing Compound Earnings
Finally, if you borrow or withdraw your retirement savings, you'll lose out on the power of compounding, where interest earned on your savings is reinvested, and in turn, generates more earnings. You'll lose out on any gains those funds would have earned for you, which, over a couple of decades, could add up to tens or hundreds of thousands of dollars in lost income.
Think long and hard before tapping into your retirement savings for anything other than retirement itself. However, if you’re in need of cash for a home down payment or other worthwhile expense, and your plan allows loans, you may be better off taking a loan rather than making a withdrawal. A loan gives you the opportunity to pay yourself back and not be charged taxes or penalties.
If a withdrawal is your only recourse, be sure to consult a financial professional about the tax implications.
Keeping Tabs On Your Accounts
So, how often should you review your accounts to make sure you’re making progress? As it applies to your contribution rate:
- Each time you receive a raise in salary, or at least once a year.
- If there is a change in the employer match level, if offered.
- If you’re falling behind in saving and need to catch up.
As it applies to your investments:
- At least once a year.
- Whenever you’ve reached a savings goal.
- If your goals, timeline or risk tolerance have changed.
- If your investments are consistently underperforming their appropriate market indexes.
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