55 And Behind On Retirement Saving?

It isn’t at all unusual for someone in their 50’s or even early 60’s to ask us for advice as they approach retirement with too little savings. As you might guess, there are as many reasons for being behind as there are people: a late start saving, frequent job changes, personal student loan debt, college expenses for their children, or just plain bad luck. Our first advice? Forgive yourself, your predicament is not about the past, it’s about the future. Let’s consider Joey’s story:

Joey is 55 years old and makes $80,000 per year. Joey spends almost all his money on clothes and sandwiches but decides he should probably get ready for retirement in 10 years. He has saved $150,000 in a retirement account and decides to save 10% of his salary, $8,000 per year, over the next ten years. Projecting average annual returns of 7% from a diversified portfolio, when Joey turns 65 he will have accumulated wealth of about $405,000. Using a reasonable withdrawal rate of 5% per year, Joey will have $20,000 per year for his expenses. Let’s add in Social Security: Joey will be eligible at age 67 and will draw $2,360 per month, approximately, at that age – $28,320 per year.

Uh, oh, at age 65 can Joey live on that $20,000 rather than $57,600 per year in take-home income he is used to($80,000 – $8,000 in retirement contributions – 20% for taxes = $57,600)? He will have to do that for 2 years until he can take that $28,320 per year in Social Security.

At age 67, his income will be approximately $48,320 ($20,000 from his retirement plus Social Security) – still well below (16% below) that $57,600 per year he needs.

So, how much will Joey need in retirement savings at age 65? He will need a total of about $585,000 plus Social Security to maintain his current lifestyle of $57,600 per year. That’s $180,000 more than he is projected to have in 10 years.

Joey has four broad options:

1. Save the same amount but earn 11.55% annually on his investments – an unrealistic expectation.

2. Save $21,000 per year instead of $8,000.

3. Work and save for a little over 14 years, rather than 10. Joey will be 69 at that time, so not completely out of line.

4. Combine strategies of saving more each year and working a little longer too by reducing his current living expenses. For instance, can Joey downsize his home and invest the savings toward his retirement?

The power of compounding is real and is a great reason to start saving and investing at as young an age as possible to be able to achieve your financial independence as soon as possible. But, as Joey shows us, life doesn’t always go according to plan. So, if you find yourself in Joey’s situation, estimate how much you will need to have saved when you retire and develop a plan to get there…and start today!

Should Cal and Rick Pay Down Debt or Save for Retirement?

There is a natural, and understandable, instinct in most of us to want to pay off our mortgage as soon as possible. In fact, it’s considered a kind of rite of passage. Yep, the missus and I paid off the house and finally have the kids off the payroll, now we can save for our retirement! But, is paying down your house or other debt early really the right thing to do for your long-term best interest?

Let’s take a closer look at a couple of common situations people face:

1. Cal owns a home for him and his family that is reasonably-priced for his family’s income with a monthly payment that allows them to pay all their expenses with a little left over. What should they do with that “extra” money each month? Pay down their mortgage or save and invest for their future? From a math perspective, Cal’s decision should be based on his after-tax cost of borrowing versus his after-tax return on investing. So, let’s assume Cal has a 30-year mortgage at 4% interest and he and his wife are in the 30% tax bracket. The true cost of that debt is 2.8% because mortgage interest is tax-deductible. So, 4% rate minus 30% equals 2.8%.

Cal’s financial planner tells him that his investments – in his 401(k) and his wife’s 403(b) – should earn a 7% annual average return, if averaged over the long term. Since that rate of return is in tax-deferred accounts, we won’t deduct income taxes from the 7% return.

So, comparing where to put that “extra” money is quite simple, right? 7% is more than 2.8%, so that’s where the dollars should go. Carrying a low-interest mortgage and investing extra dollars into your retirement is a wise decision since your investments will have a better return than what the debt is costing you. In other words, Cal will be better off investing at 7% than avoiding a cost of 2.8%.

2. Rick has a good income because he went to a good university and graduate school but he has student loan debt. Should he put his “extra” money into paying down his student loans or into his retirement accounts? First, we would tell Rick to, at the very least, put enough into his retirement accounts to receive the match from his employer. Don’t give away the free money. After that, the calculation is the same as above. This time let’s assume the student loan interest rate is 6.5%. Let’s also assume that Rick’s financial planner tells him he can expect to earn an average of 7% over the long term from his investments. As a high-earner, Rick is in the 35% tax bracket. As most student loan debt is not tax-deductible, we won’t lower the interest rate for comparison. And, as above, Rick’s investments are in his work 403(b), we won’t lower the return number either.

So, should Rick pay down his loans or sock more into retirement? Although the student loan interest rate is lower than the rate of return from his investments, it is close enough that he should put that “extra” money into paying down his student loan debt. (We would recommend he explore refinancing his student loans to get a lower rate but that’s for another discussion)

Student loan debt is a deterrent to saving enough for retirement for many young people and all options should be explored in order to put your money to work for your future self as soon as possible.

Like many things, debt is okay in moderation and under the right conditions, if it helps us purchase things that will help us. Debt for a home with a competitive interest rate at a payment that allows you to pay your expenses and save for retirement – probably good. Six-month old credit card debt for Chinese food you can’t even remember eating – probably bad. As always, having a plan to retire debt and reach your goal of financial freedom will help get you to both faster.

If you want to examine your own personal situation, use the online calculator here: https://www.calcxml.com/calculators/pay-off-debt-or-invest.