Get Retirement Right: 3 Keys To Long Term Financial Success
- May 26, 2020
- 11 min read
- 30 reads
Get Retirement Right – Find Out How Much You Need To Retire Early?
The Retirement Dream
This has been a hot topic of conversation with my family lately. My parents are less than five years away from retirement. Divorced and living extremely different lifestyles, but they both want to get retirement right.
My dad custom builds classic vehicles. He lives close to the city and loves meeting for brunch.
My mum recently sold her jet ski and is reluctant to part with her spear gun. My last vacation with her was diving the Great Barrier Reef in Australia.
My siblings and I fittingly call her ‘Adventure Mommy.’ How they ever got together and made four children blows my mind.
Both parents have made really different financial choices, mom always saved and diligently put money into her retirement funds. Dad, on the other hand, invested in property early in his career.
But all this retirement talk got me thinking, what do I really want my retirement to look like? How much do I need to retire? How early can I retire?
The idea of owning my time and doing what I love all day is blissful. Going from a part-time investor to a fulltime investor is my usual 3pm maladaptive daydream.
My Retirement Values List
- Enough investments to pay for my lifestyle
- Live by the beach
- Have enough money to travel
- Live close to my family
- Be healthy and young enough to enjoy it
The list part is the easy part. Identifying what you want out of life will enable you to build a financial strategy. Now the hard part is to turn that list into an actionable plan.
Saving and planning for retirement may seem overwhelming. Online calculators that will say, ‘You need 6.5 million dollars to retire.’
That’s like telling me I need to lose 6.5 million pounds! It’s unrealistic people! Teach me the basics!
3 Keys to making sure you and I retire right.
Set Up Accounts
1. Plan For Retirement
Planning for retirement and committing funds towards it can seem difficult. Often our income seems already committed to monthly living costs and other savings schemes.
Planning for retirement can be a snore-fest. Saying no to things now so you can sleep peacefully in your older years is hard at first. Retirement seems far away. But if you don’t make a plan and stick to it, you might find yourself living on struggle street in your old age, and last I checked it’s nowhere near the beach.
Decide what you want retirement to look like, then set a plan as to how and if you can make that happen. Then breakdown your plan into yearly goals.
If you’re like me and dream of a ‘boujee’ retirement, then you may need to get investing early. Upskilling, side hustles, and knocking your debt down quickly will move you into a snowball effect with your savings.
2. Set Up Retirement Savings Accounts
Before you do any other investing, set up a 401(k) and an IRA.
A 401(K) is a retirement savings plan that you can get through your employer. Most employers offer matching contributions to a set amount. There is only one thing better than putting money into your savings account. That is someone else putting money into your savings account.
The funds deposited into your 401(k) are pre-tax dollars. This means you will accumulate interest on a higher amount of money than if you were after-tax deposit dollars.
There is an annual contribution threshold of $19,500 or $26,000 if you’re over 50. If your employer doesn’t offer a 401(k) fund option, then inquire if they offer a SEP IRA or a SIMPLE IRA employer plan.
If you can save more than your 401(k) contribution limit, make deposits into an IRA.
An IRA is a personal retirement account that you set up through a financial institute. The contributions are also pre-taxed, but no magic person is matching your funds, so that’s disappointing. On the bright side, all contributions are tax-deductible, meaning you can pay less annual tax on the years you contribute. There is a yearly contribution threshold of $6,000.
So, you’ve set up your 401(k) and IRA, but that might still not be enough. Now it’s up to you to build your wealth through investments. There are many options available, and you don’t need millions to start.
Need to learn more about investing? Check out our blog on the top 20 best finance podcasts here.
Diversification is key to having a healthy investment portfolio. Don’t place all your eggs in one basket, such as mutual funds or property.
It’s a good idea to begin diversifying early on with small amounts. That way, if one industry is suffering, another may grow. Diversifying will balance your portfolio through mutual funds, index funds, national and international indexes, and property.
The FIRE movement is continuing to grow as more people want financial independence far sooner than retirement.
To achieve long term financial freedom-seeking professional help from a financial advisor will be hugely beneficial. You can study all the jargon and apply the ‘learn as you go method, but you only live once. You have one shot to capitalize on your best earning years, so use them well.
Invest wisely the first time by diversifying your funds over different markets will ensure your financial future.
How Much Do You Need To Retire?
Most experts say you need about 80% of your pre-retirement income to retire comfortably.
This amount assumes that your living expenses have reduced because you have paid off your mortgage and have little to no debt by the time you retire.
As a scenario, if you make $100,000 annually now, then you will need roughly $80,000 annual income post-retirement.
Your retirement income can come from many sources. Some will be from your retirement savings and profit from your investment portfolio. Other sources of income may come from specific pension plans depending on the industry you worked in or social security.
The 4% Rule
The 4% rule has become increasingly popular. As a rule of thumb, if you withdraw 4% of your investment portfolio value each year during retirement, you mitigate the risk of running out of money. This formula assumes a 5% return after tax and inflation on your investment portfolio.
An easy formula to work out how much money you need to retire is to divide your desired retirement annual income by 4%.
In this scenario, let’s say your desired retirement income is $80,000.
$100,000 / 0.04 = $2,000,000.
You are maybe looking at this figure, feeling overwhelmed. How on earth am I going to save $2 million? For most people, this is a massive number.
But if you start your retirement savings plan early and diversify your portfolio, the compounding interest on your investments will grow over time.
It is possible!
How Much Do I Need To Retire Early?
How much to retire early depends on your investment strategy and your portfolio returns. If you need $80,000 a year to live comfortably using the 4% rule, you would need $2 million invested in a diversified portfolio and through your retirement savings plans.
The younger you retire, the longer your investment portfolio income has to last you. You will be able to fully retire when you can live off the profit from your investments without digging into your capital investment.
If you abide by the 4% rule, then your investments will need to return you at least 5% in annual return to compensate for fees, etc.
If your portfolio was delivering a much higher return, then you could potentially retire earlier. The way to work that out is simply to divide your needed annual income of 80,000 and divide it by the percentage return you are receiving.
Eg, $80,000 / 6% = $1,300,000 (rounded).
This means you could retire off $1.3 mil if your portfolio was delivering a regular 6% annual return.
Remember, when working out your investment return, be sure to keep aside between 1 – 2% of your return for inflation and fees. It would be beneficial to obtain an 8% annual return on your investments if you are intending to live off a 6% return. This will ensure you don’t encroach on your investment capital.
If you do not set aside extra for inflation and fees, you will begin to eat in your capital.
How Much Should You Save A Month?
How much you should save for your retirement will depend on how old you are and your previous savings. The rule of thumb is to save 20% of your income from the beginning of your career. With 75% of that savings going into your retirement. But not everyone began saving for their retirement that early. I sure know I didn’t.
The reality of needing to save for retirement hit me in my early 30’s. I made up for lost time once I realized the value of becoming financially independent.
But I often wonder how far along I would be if I started earlier. Oh well, no regrets, I traveled the world and wore amazing shoes in my 20’s and to be honest, that seemed far more exciting than saving for retirement at the time.
Making extra money fast can give your savings the boost they need.
Lets’s say you were smarter than me in my 20’s, and you are straight out of grad school and want to begin putting money aside for retirement. Great idea, smarty pants!
You now know you need to find $2 million to retire if you want to adhere to the 4% rule. Let’s say you’re 25 that gives you 40 years to build up your portfolio.
Using an average 6% annual return on investment (because the younger you are, the more risk you can take), we can use this nifty formula that I highly recommend keeping somewhere.
Annual Savings Required = (Retirement Savings Total x r)/((1+r) n -1)
r = rate of return (as a decimal)
n = Years of saving
($2,00,000 x 0.06)/ ((1+0.06) 40 -1)
Annual Savings Required = $12,923
This amount is subject to change if the annually as your rate of return fluctuates.
Planning can be a moving target, having a few formulas up your sleeve will help keep you on track to your retirement goals.
The annual savings required formula helps make that $2 million mountain seem less steep.
In fact, if you start young or ramp up your savings, you will make it. Becoming financially independent will ensure your later year are focused on the things that matter.
How Much More Do I Need To Save To Top Up My Pension?
If you work in a public sector or have access to a retirement pension, you can calculate the retirement income gap between your pension and the supplementary income you will need.
Heres a scenario. Let’s say you’re 32 want a retirement lifestyle of $80,000 per year. Your retirement pension annual income is $42,000, which is to be paid out from the age of 65. You want to have that lifestyle for the next 20 years, and you expect a real rate of return on your retirement savings and investment portfolio of 5%.
You can calculate the annual retirement income gap by subtracting your pension amount from your income requirement.
$80,000 – $42,000 = $38,000
We can now work out the retirement income gap total needed by 65 to retire with an $80,000 income including pension payments.
Retirement Income Gap Total = C x [ (1 – (1+i)-n) / i ]
C = Cashflow per period
i = Rate of interest (as a decimal)
n = Years of payments required
Retirement Income Gap Total = $38,000 x ((1 – (1+0.05) -20) /0.05)
Retirement Income Gap Total Needed by 65= $473,564
For those that are not big on finance formulas, I get it, but these bad boys are highly beneficial when you want to make sure you are on track.
How much will you need to save each year?
If your savings are deposited into a mutual fund with a 5% average annual return, you can use the below formula to determine how much you need to save each year.
Annual Savings Required = (Retirement Savings x r)/((1+r) n -1)
n = The years of work you have left = 23 (65 – 32 = 33 years)
r = Rte of return (as a decimal)
Annual Savings Required = ($473,564 x 0.05)/ (1+0.05) 33 -1)
Annual Savings Required = $5,915
With both my parents getting older, the retirement conversation has been surfacing a lot with my siblings. Like most kids, we believe we know what is best for them because, well, you know, they’re old.
Fortunately, from the looks of things, however, they are going to be just fine. One less thing to worry about, fewf.
How is your financial retirement plan shaping up? Are you on track to retiring early? Comment below.