Click to enlargeAnyone will tell you that saving for retirement is definitely not one of the most enjoyable things to do. As a matter of fact, it's downright difficult. There is always the temptation to buy extras for your vehicle, or splurge on a night on the town, when you see that bonus in your paycheck.
After all, why work if you can't enjoy your money now?
The younger you are, the more this type of mindset can be a problem. That's because, at a younger age, it's tough to see yourself as an older person in your retirement years. And, certainly, it's not very pleasant to view oneself as an older person, who could be wondering how to pay the bills or pay for medical care!
We tend to brush these thoughts aside until the actual reality hits home. But, the truth remains -- it is far easier to save at a younger age, than it is to save when you're past middle age.
I'd like to share with you a few practical reasons why saving at least 20% of your income can be the most critical decision in your life.
The Reality of Social Security
A large percentage of people consider Social Security to be their "safety net," upon retirement. However, this can be a serious mistake. Why? Well, according to the report issued by the Social Security Board of Trustees, the trust funds for Social Security will be depleted by
However, this can be a serious mistake. Why? Well, according to the report issued by the Social Security Board of Trustees, the trust funds for Social Security will be depleted by the year 2033.
Now, does this indicate that Social Security will disappear, altogether, by 2033? No, it doesn't. But what itdoes mean is that, according to current laws, the benefits that will be paid out will need to be limited to the amount which can be supported by collected FICA taxes from the workers during that time period.
In keeping with this, the report that was issued by the Trustees indicated that the estimated FICA taxes, which will be collected in 2033, will only cover 75% of the scheduled benefits, at that time. I'm sure it's easy to imagine what a 25% cut in Social Security benefits will mean to the affected senior citizens, who will use Social Security as their primary source of income. Saving for retirement, which has amounted to 20% of your working income, can easily fill the 25% gap, in Social Security, and also provide for a better retirement lifestyle.
I'm sure it's easy to imagine what a 25% cut in Social Security benefits will mean to the affected senior citizens, who will use Social Security as their primary source of income. Saving for retirement, which has amounted to 20% of your working income, can easily fill the 25% gap, in Social Security, and also provide for a better retirement lifestyle.
Saving for retirement, which has amounted to 20% of your working income, can easily fill the 25% gap, in Social Security, and also provide for a better retirement lifestyle.
Health Insurance Concerns
In addition to the income benefits reduction in 2033, the Trustees report also indicated an estimation of depleted Medicare Hospital Insurance Trust Funds (NYSE:HI), as well.
Here, they reported that by 2030, only about 85% of inpatient/hospital expenses will be covered by that Trust Fund. This leads us to the point that it's also possible that you may need to pay for a health insurance policy, on your own, by the time that you retire.
Even if your current (or future) employer has indicated that they will cover your health care upon your retirement, that doesn't mean that it's a complete guarantee.
Indeed, it's possible that a company promise, regarding medical coverage, can be broken decades down the road. Also, while you may feel that working for government positions will offer greater security - that may not always be the case.
Here, you need to consider the various types of financial/budget stress that are, even now, being felt by state/local government offices.
Even today, we are already seeing various types of benefits budget cuts.
With a dedicated saving for a retirement plan, that equals at least 20% of your working income, being able to afford a good health care policy would be no problem at all.
Current Reliance on Personal Savings
One of the best indicators of how savings can play a large part in one's income management can be seen by the current budget activities of older people. It may be a good idea to speak with an older relative regarding their ability to deal with their ongoing expenses.
It's not at all uncommon to see retirees who have saved throughout their working years and are now able to maintain their own homes, pay all their bills, enjoy their retirement and even be able to afford a comfortable assisted living facility should that become a necessary option, in the future.
Then, there are those who have neglected to save a sufficient amount, throughout the years.
Here, you may see an older person who is forced to move in with one of their children and forego any plans for travel or other retirement pleasures.
When you look around, you will notice the increasing number of households in which different generations of family members live. This can become a definite reality for those retirees who have no pensions, not enough savings and reduced Social Security benefits.
Depending on a Future Pension
Many people think of their retirement years in terms of a good pension, along with Social Security.
The reason for this comes from the fact that this is the way retirement has been portrayed in the media, over the years. It may also be the way your own parents have originally experienced their retirement.
Sadly, relying on a traditional pension is quickly becoming a disappearing reality.
For example, when you look at private companies, you will notice that many of them are no longer offering pensions, at all! The reason for that rests with the fact that people are living longer, and companies don't want to be burdened with an increasing pension payout.
Even those companies that traditionally offered pension plans are reworking those plans so that new employees are no eligible for a pension. Many companies are even "freezing" their current pension plans.
Investment Returns Might Come Back to Earth
It should also be noted that there is a coming collapse in investment returns. This will result in the necessity for those who are at 30 years of age to work an additional seven years (or possibly saving almost two times as much) in order to meet the same nest egg level that was attainable by those who worked only a generation ago!
This prediction can be found in a report that was issued by McKinsey & Co. The report concludes that the investors of today need to understand that their investments will produce diminished gains.
The reason for this rests on the fact that the previous 30 years have represented a "golden era" of returns that consisted of outstanding inflation-adjusted returns due to various scenarios that will not be repeated.
These include; an expanding stock market price-earnings ratio and swelling corporate profits. This means that now, more than ever, saving for retirement is a critical matter.
Future investment returns can be hurt by "Boomers" retiring in massive numbers
A prediction that has been issued by noted author, investor, and entrepreneur, Robert Kiyosaki, has indicated that we may be experiencing the biggest Stock Market crash, in history, will be coming our way in 2016.
This is in keeping with what the Wall Street Journal related, regarding the effect that retiring baby boomers are having on the markets, as we hold tight and wait for Millennials to pick up the savings slack in the coming 2020s.
However, here are a few points to consider:
- The majority of these outflows are probably being rolled over into IRAs to simplify and aggregate retiree portfolios. This means that the money is not being taken out entirely from the market.
- About 85% of the wealth in this country is held by 20% of its individuals. It won't come out all at once, and much of it will be passed on to future generations.
Saving for Retirement (at least 20%) is a MUST
I run a simple forecast to explain that saving 20% of annual income is a MUST in a low return environment. I used median personal income data from Census Bureau and extrapolated it out over forty years.
If you would like enjoy predictable returns that come from a reliable investment portfolio without having to rely on the stock market, you would need to place your retirement savings into a portfolio ofinvestment-grade corporate bonds.
The average US corporate bonds master effective yield is 2.93%, as of today. For this calculation, I usedinflation rate data set at 1%. This means, then, that the inflation-adjusted yield of the US Corporate bonds is nearly 2%.
In addition, I assumed that the inflation-adjusted yield of the portfolio (real rate of return) will be nearly the same (2% over the next 40 years).
Please note that all calculations are made in 2016 money.
To illustrate how much savings is required for your future income on top of median Social Security, here is a chart that you can refer to:
I used a 4% safe withdrawal rate from your accumulated retirement funds plus median Social Security benefits.
We can see that taking into consideration a real rate of return at 2%; we get a result that proves that only by saving 20% of one's gross income will they be provided with a retirement income that is similar to their pre-retirement income (less contributions).
Of course, tax bills will be far smaller during retirement, when compared to payroll taxation. It can even bezero, if you manage to pay all taxes during the accumulation period.
However, we have already noted that Social Security benefits and Health Insurance are not guaranteed or predictable.
So, what is the key to an enjoyable retirement?
As you can see, there are many reasons why saving at least 20% of your income, for retirement, can allow you to avoid different monetary problems, in your future.
When you do the math, all you need to do is to take 20% of your income and multiply it by the number of years that you plan to continue working, prior to retirement. This will give you a good idea of how you will be able to afford a comfortable retirement lifestyle, especially when that amount is combined with any Social Security, or other benefits, that you may receive.
One of the best ways to approach this goal is to set up a plan in which you have automatic transfers to your savings and investment accounts. This way, it becomes much easier to adjust to a lifestyle that takes your savings into account.
Doing things, in this manner, can remove the temptation to just "make an exception" this time, when you see that new laptop or flat screen television being advertised online.
You should not rely on the financial market and not dream that the stock market will help you to become rich very quickly. Therefore, you should expect to use financial market only to save money and protectmoney.
To have enough income to support your style of living, and save enough for retirement, you need to find a way to earn extra money and not just rely on the payroll from your employer.
Once you see the way that your savings are building up, you can begin to imagine a more independent and enjoyable retirement lifestyle. I would say that this is far more preferable than having to worry about your bills or having to consider moving in with a son or daughter.
I'm sure you think so, too!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclosure: IncomeClub is an online investment advisor, specializing in bond investing. Whether you are new to bonds or an experienced bond investor, we provide deep expertise in fixed-income investing, individualized advice, access to global bond markets, and convenient online account management. IncomeClub, Inc. is a SEC registered investment adviser. All IncomeClub’s customer assets are held in the customer’s name with Interactive Brokers, LLC, Member FINRA/SIPC.