Last Week’s Question of the Week: According to the Federal Reserve Board, in 2018, how many households receive an inheritance each year? Is it 500,000 or almost 2 million households?
ANSWER: The Federal Reserve Board’s Survey of Consumer Finances reports that an average of roughly 1.7 million households receive an inheritance each year.
HOST: I know that your firm’s focus is on helping people plan for retirement, so I am assuming most people have questions about how much they should be contributing to retirement plans. What is considered average?
KLAAS FINANCIAL: Yes, it really is an important question that we answer as we get to know our clients. But let’s first start with a look at when people really think they are going to retire and the reality of when they actually do.
According to Gallup research, those currently employed project that on average, they’ll retire at age 66. This number is misaligned with reality however, as the current average retirement age is 63. The average retirement lasts about 18 years. However, most future retirees believe that the age of 61 is the ideal retirement age.
So, in light of the statistics, understanding that contributing to your company retirement plan (providing you have one, such as a 401k/403b) is a smart way to save for retirement, or into an IRA if you don’t have access to this type of workplace plan. Many people wonder how they compare to their peers in terms of savings and Fidelity has some recent studies that shed light on this.
The maximum that you can contribute into traditional employer retirement plans is $19,500 + $6500 (catch-up in 2020/2021). According to Fidelity, the average amount participants invested in a defined contribution (DC) account was $7,270 over the 12-month period ending Sept. 30, 2020. Many participating employees also received matching funds from their employers. In fact, the average employer contribution during the same period was $4,010.
Altogether in 2020, employee and employer investments added up to a combined average total savings rate of 13.5% of income. Fidelity’s data shows only around 73.3% of workers who were offered the opportunity to put money into a DC plan choose to do so, meaning over a quarter of workers opted out.
Investing 13.5% of income for retirement is a pretty good amount, although ideally the combined contribution rate would be closer to 15-20%. Still, investing $7,270 each year over a 30-year career and earning an 8% return would leave you with a nest egg of almost $830,000, even before any matching funds were factored in. These are average rates, which may be driven up by those contributing a substantial percentage of pay or receiving large employer matches.
HOST: So, what if you are contributing less than the average? What should you do?
KLAAS FINANCIAL: Yes, so this is the problem with comparisons … your contributions don’t necessarily need to meet these averages, or in some cases they may need to exceed them. The important thing to focus on is that you’re contributing enough to hit your personal retirement savings goals, and that amount will depend upon how young you are when you start saving and how much you plan to spend in retirement.
Set your retirement savings goal: How much do you want to have by when? Consider how much you will distribute from the savings on an annual basis. Make sure that you are investing enough to meet it.
How to boost your retirement savings: Look carefully at your budget for cuts so you can contribute more. Looking at all of the areas where you didn’t spend money in 2020 may be a good reason to move some of those dollars towards retirement accounts in 2021.
As you get a raise, you can also increase your contributions. If you’re currently investing 7% of your salary, for example, this would mean increasing contributions to 8% if you get a 1% raise. It may take some sacrifice to get your contributions up to the necessary level, but it’s worth doing if you want to take the first key step toward a secure retirement. Make sure you are putting away enough to get your employer’s full match if they offer one.
No available employer retirement plan? Consider maximizing a yearly IRA or ROTH IRA contribution for yourself and your spouse if you have one. ($6000 or $7000 catch-up in 2020/2021). Although the maximum contribution limits are much smaller, getting a tax break now may make sense, or later if you choose to go the ROTH direction.
Add money to an after-tax investment account to put in additional monies that you are earmarking for retirement. Although these are not defined or deferred tax accounts, and you will be paying for your gains along the way, this will also be a wonderful account to draw money from especially in the case of an early retirement (prior to 59.5) as you will not be penalized for taking from them too early, and you will not be paying income tax as the monies come out.
HOST: What about when you are done accumulating? How do you correctly plan for a distribution strategy?
KLAAS FINANCIAL: Moving from the Accumulation Phase to the Withdrawal Phase is one of the biggest changes you’ll face in retirement, and it’s critical that you have a plan for your transition. In essence, how much should you take per year? How much do you need to live the type of retirement you want? How much can you afford?
Important things to plan for:
- Debt Reduction: Having any outstanding debt reduced or eliminated will allow for you to take less from your retirement accounts. Paying off your mortgage for example.
- Addressing Risk: You will want to begin reducing your risk in your portfolio as you get closer to retirement. This will likely be a look at rebalancing your investments more conservatively depending on your timelines.
- Emergency Savings: Make sure that this buffer account is available and there in post-retirement, just like it was in pre-retirement. Emergencies don’t stop just because your retired.
- Withdrawal Amount: Plan for an appropriate amount to withdraw from your retirement savings (4-5% depending on your age, and your financial situation) to supplement your other income such as Social Security, pensions, spousal income, part-time income. Considerations of longevity and health may play a part.
- Tax Considerations: From which accounts will your income come from? Will it be from tax-deferred accounts where you will need to plan for a lower net amount once you account for taxes? Or will it be from appreciated stock accounts where you will have to pay long-term capital gains?