Your Retirement Plan: How to Get Started

Estimating your retirement income

It's never too early, and rarely too late, to start or improve a retirement plan. Retirement planning breaks down into three steps: estimating your retirement income, estimating your retirement needs, and deciding how to invest what you save to close the gap between the two. Estimate conservatively at every step; it's a far better problem to have more than you projected than less.

Most people draw retirement income from three sources: Social Security, pension payments, and their own savings and investments. Since Social Security and pension income are largely outside your control, the amount you'll need to generate from savings and investments can only be determined once you've pinned down realistic estimates for the other two.

Social Security. Request an estimate of your future benefits directly from the Social Security Administration, either online through their website or by calling their toll-free line. Some people receive these estimates automatically in the mail without requesting them. Your eventual benefit depends on how long you worked, your total earnings, and the age at which you start collecting. Waiting until your full retirement age, 65 to 67 depending on your birth year, produces a larger monthly benefit than starting at 62. Keep in mind that Social Security benefits can be subject to income tax: if your adjusted gross income, plus tax-exempt interest, plus half your Social Security benefit exceeds $25,000 for an individual or $32,000 for a couple, a portion of your benefit becomes taxable, and that taxable portion grows as your income rises. If you continue earning income while collecting Social Security before full retirement age, your benefit may also be reduced.

Pension and employer plans. If you're covered by a traditional pension and are vested, ask your employer for a projection of what you'd receive at retirement age, or under other circumstances like leaving before retirement age. If you participate in a 401(k), profit-sharing plan, Keogh plan, or SEP, estimate the lump sum you're likely to have available at retirement; your employer or plan administrator can often help with this. If you served in the military, contact the relevant branch of service about retirement benefits you may be entitled to.

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Setting your retirement goals

Once you've estimated what's coming in from Social Security and any pension, the next step is figuring out how much income you'll actually need. Many people underestimate how long retirement lasts; it can stretch 35 years or longer, potentially as long as your working career. The earlier you plan to retire, the more you'll need saved, since that nest egg has to stretch further.

A common starting benchmark is that you'll need roughly 70% of your pre-retirement income to maintain your standard of living, adjusted upward if you're planning something income-intensive like extensive travel. Treat that figure as a rough guideline, not a substitute for actually working through your own numbers.

To build a more accurate estimate, start with your current annual expenses: pull a year's worth of checkbook, credit card, and bank records and total what you spend on housing, insurance, food, and everything else. Then think through how those expenses are likely to change after you stop working. Will your mortgage be paid off? Will commuting costs disappear? How much will health coverage cost if you're not among the shrinking number of retirees with employer-sponsored retiree health benefits, since most people end up paying more out of pocket for Medigap-style coverage after leaving a job? Will your life insurance needs go up or down? Will travel or hobby spending increase? Will your children still need financial support, or will they be independent by then? Will you owe more, less, or about the same in income tax, and if you're planning to relocate, what will the new state's tax treatment look like?

Once you've projected your annual post-retirement expenses and subtracted the income you already expect from Social Security and any pension, whatever is left is your annual shortfall, the gap your savings need to cover. From there, a savings multiplier table (assuming a conservative 5% after-tax return) can translate that shortfall into an annual savings target. For example, someone who determines they need a $350,000 nest egg 25 years from now would multiply that figure by the 25-year savings multiplier of roughly 2.1%, arriving at about $7,350 a year in required savings. If that same person already has $75,000 sitting in a 401(k), applying a 25-year growth multiplier of roughly 339% shows that balance alone would grow to about $254,250 by retirement, cutting the amount still needed to accumulate down to roughly $95,750, or about $2,011 a year once the existing balance is credited.

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Deciding on investments

As a general rule, the further you are from retirement, the more of your savings can reasonably sit in growth-oriented investments, and the closer you get, the more it makes sense to shift toward lower-risk holdings. That said, this is only a starting framework; your actual mix should reflect your personal risk tolerance, income level, other sources of retirement income, and individual circumstances.

Each year, prioritize maxing out tax-deferred savings vehicles like a 401(k), IRA, or Keogh plan. Because that money grows tax-deferred, and deductible contributions also reduce your current taxable income, these accounts do double duty. Money market funds, CDs, and Treasury bills sit at the conservative end of the spectrum; of the three, only Treasury bills reliably keep pace with inflation, which is why most retirement portfolios use these vehicles as only one piece of a broader mix rather than the whole strategy.

Bonds offer a fixed income stream and generally pay more than Treasury bills, though their value fluctuates with interest rates, making them riskier than cash-equivalent holdings; shorter-term bonds tend to hold their value more steadily if you're using bonds conservatively. Stocks carry the most risk of the categories discussed here, but also the greatest potential for long-term growth. Mutual funds are a practical way to hold a balanced mix of both, spreading risk across many underlying securities while still aiming for meaningful growth.

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