Preparing for retirement can be challenging. One of the most important things you can do is ensure the health of your overall retirement nest egg and understand your financial goals. One step you can take is to check on your retirement savings accounts – like a 401(k) [also known as an individual retirement account (IRA).]
In this article, we’ll discuss how much you may need in your 401(k) once you retire and things to consider before you begin to make withdrawals from your savings.
What Is a 401(k)?
A 401(k) is a retirement savings option employers offer their employees. This tax-deferred retirement account allows employees to contribute pre-tax dollars to accumulate assets for future retirement. This retirement savings plan has tax advantages. These savings accounts allow individuals to save money without paying income taxes on those contributions until they withdraw the money during retirement. Contributions are made either through payroll deductions or direct deposits.
When employees sign up for a 401(k), they agree to have a portion of their paycheck paid into an investment account. Employers may choose to match part or all of an employee’s contribution. It is equivalent to passing up free money if you do not participate. Even if an employer doesn’t offer matching contributions, the tax advantages of a 401(k) still make this one of the best ways to save money for retirement.
How Does A 401(K) Earn Money?
A 401(k) typically pays benefits through a combination of monthly service fees and returns earned on the money in the account. It works like a typical savings account, adding interest based on climbing rates over set periods of time. This means the more money you save in your 401(k), the more potential it has to earn you money throughout its allocations. These allocations are investments such as stocks, bonds, or mutual funds. Careful monitoring is suggested to make sure you are getting the best possible rate on your investments and to ensure any service fees attached match up with current market prices. Ultimately, a 401(k) can be an incredibly lucrative way to save for retirement – if managed correctly!
Calculating the 401(k) Funds You Need Before Retiring
To calculate how much money you need to set aside for retirement, you will need to make assumptions about your future income and expenses. For instance, if you expect an increase in salary or bonus each year after age 55, you may not need as much money saved for retirement as someone who expects to work with minimal increases until they reach 65.
On the other hand, if you expect to spend more money in retirement than you did during your working life, you might need more savings in your 401(k).
A good rule of thumb is to estimate how much you would need to maintain your current lifestyle throughout retirement. If you are uncertain, ask yourself these three questions:
- How old am I?
- What is my expected annual income level?
- How long do I expect to live?
Factors That Contribute to How Much Money You Need in Your 401(K) Retirement Accounts
When planning for retirement, it is important to take several factors into account when determining your contribution rate. Life expectancy and the health of both you and your spouse are important factors to consider in determining how long your money needs to last. In addition, inflation, the cost of healthcare, and the lifestyle you wish to maintain after leaving the workforce should all be considered when coming up with a number.
Saving early can help you avoid saving significant sums of money later on. While taking advantage of tax deferrals while they are available is also beneficial. This can help create financial security by knowing you have adequate funds saved for retirement.
Here are three other factors you’ll want to consider when evaluating your 401(k) retirement savings accounts.
1) Living Expenses
Of the various factors that determine how much money you will need to save, the cost of living is a significant one.
For example, if you plan to retire in Hawaii, it would be nice to spend your days surfing on Waikiki Beach. However, the cost of living there is extremely expensive. You will need to make sure you have saved enough money for retirement, so you don’t run out of cash before you can afford the costs of living there.
Cities, such as New York and Los Angeles, also have relatively high housing prices. They also tend to be very expensive in other aspects. In contrast, more remote places have much lower housing prices, and their overall cost of living tends to be lower than big cities. If you want to make the most of your retirement dollars, you might consider settling somewhere more remote and cost-effective.
2) Tax Policies
You should also be aware of the tax policies of the states where you plan to retire. Each state may have different rules and tax rates. To avoid paying state income taxes, for example, residents of Texas can make use of retirement accounts such as 401k. However, due to extremely high property taxes in most areas, many people opt to move elsewhere.
3) Property Taxes
As mentioned above, property taxes can vary greatly depending on where you choose to live. While some states do not charge state taxes, the cost of property taxes can fluctuate. The states below do not charge income tax and have a low tax burden.
Do your research before determining what state works best for your retirement needs. Find more states with no income tax and low tax burdens and learn about their other tax advantages before you relocate.
4) 401(k) Contribution Limits
Your 401(k) contribution limit is set by the IRS each year and will vary depending on your age and income level. If you exceed the annual savings rate limit then there may be financial penalties in addition to regular taxes that must be paid on the amount over the limit.
Budgeting Your Annual Salary For Retirement Funds
You may not know what you want to do when you retire, but you should know how much retirement money you need to save each month. How do you determine how much money you need? It depends on your age, lifestyle, annual salary, and retirement goals. It also depends on your spending needs and bills.
Consider making a budget to determine what you’ll still be paying when once you’re a retiree:
- Credit card debt – will you be paying on credit cards still or can you afford to pay these off before you retire to give checking accounts a boost?
- House payment – how many more years of paying on your house do you have? Will it be paid off before your retirement?
- Car payments – will you pay off a car or will you plan to get a new one?
- Property taxes – even if your house is paid off you’ll still need to pay property taxes.
- Insurance – from health insurance to house insurance, what do those dollar amounts look like once you’re retired?
- Are you saving for a child’s education?
These are just a few things that you will need to account for when looking at your retirement plan and savings. Adjust your savings and pay off what you can beforehand to ensure you have enough money to support yourself and your spouse once you stop working.
Can I Reduce My Expenses During Retirement?
The Employee Benefit Research Institutes (EBRI) study on the Expenditure Patterns of Older Americans shows us that as the population gets older, expenses decline. Using age 65 as a benchmark, household expenses drop by about 19% by age 75 and 34% by 85. While people over the age of 50 spend roughly 40-45% of their budget on their homes and home-related items. Essentially, by the year you retire, your expenses should be reduced between 20% and 40%. Most guidelines of how much you should save range from 60% to 80%, depending on your personal situation.
If you have a retirement income of $100,000 per year when you retire and you want to live off of 80% of that income, you need an annual income of $80,000 to maintain your lifestyle. You may need to withdraw as much as $80,000 annually from your 401(k).
But what if your household earnings at retirement are $200,000 and only one million dollars have been saved? Does this mean you really only possess half of what you will require to retire comfortably? Having an evaluation done by a financial professional can help to show you how much money you have, and how much more money you may need to live the life you want or give you steps to meet your retirement goals long before you plan to retire.
What to Know Before Making 401(k) Withdrawals
While we’ve primarily focused on how much to save and the importance of budgeting before retiring, it’s also crucial we touch briefly on withdrawing from a 401(k). Before considering taking withdrawals, understand the consequences of doing so. An early withdrawal penalty will occur if withdrawals are taken before turning 59 and a half.
Moreover, the IRS taxes those funds when they are withdrawn due to not being managed over the long term as intended. For both pre-retirees and retirees alike, understanding that 401(k)s should not be viewed as penalties-free sources of cash before retirement age is vital. Withdrawals can undoubtedly help in difficult times but should be considered a last resort due to their long-term negative impacts on retirement savings for any retiree.
Start Saving For Retirement Early
The decision regarding where you want to spend your retirement years has a considerable impact on how much money, and therefore time, is needed to save.
Why should you start saving for retirement early? Because of the power of compounding—the idea that money invested today has more time to grow and thus can earn more. This means the sooner you start saving, the less you’ll need to save each month to meet your financial goals, and the less you risk not being able to live the life you want during your golden years.
Stick to Your Retirement Savings Goals
People who work in finance know it takes a lot of planning to save enough to meet retirement goals. You may think you may not live long enough to retire, but with today’s medical technology, people are living longer and healthier lives than ever before.
Having the discipline to stick to your savings goals can help you to retire on your timeline.
When to Work With a Financial Professional for your 401(k)
As a retiree, you have earned the right to enjoy the 401(k) funds you’ve been investing throughout your entire working career. To ensure finances are managed in the most secure and efficient way possible, you should strongly consider working with an experienced financial professional to understand your investment options. It can be intimidating to navigate through post-retirement investments on your own, and mistakes in investments can have lasting effects.
Financial advisors can provide a trusted resource to help support you every step of the way. They have the knowledge and resources to develop personalized strategies specific to a retiree’s needs, such as tax planning and estate planning.
With their guidance, you can rest assured you can make better investment decisions for yourself and for any future generations you want to provide for. Seeking investment advice can be advantageous for investors in the long run.
The Bottom Line on Your 401(k)
There are many essential factors you need to consider before retiring. Knowing how much is in your retirement savings accounts is one of them.
As you prepare for retirement, think about how much you plan to spend, if you plan to move, and the other things we mentioned above. If you’re starting to save for your golden years, keep in mind the earlier you start to save, the better off you are.
Tips to Help You Get Ready for a Comfortable Retirement
Consider joining Planning Made Simple. When you join as a new Planning Made Simple member, you receive a financial evaluation of your retirement savings by your Planning Made Simple Coach.
Our coaches have years of experience in the financial industry and can help to educate you on ways to improve your financial decisions, answer questions, and provide investment guidance.
Speak with your financial advisor on the overall health of your retirement plans and financial goals. If you don’t have a financial advisor and aren’t sure why you need one, check out our article, What Is a Fiduciary Financial Advisor and Why Do You Need One?