- Want to retire comfortably? You’ll need to replace 80% of your pre-retirement income.
- As of 2016, Uncle Sam doles out an average monthly payment of $1,300 to eligible retirees.
- The higher your annual income, the less money you can expect from Social Security when you retire.
Can you rely on Uncle Sam to fund your retirement?
Just what are your retirement income plans? Think Social Security benefits will fill the gap? Think again.
For the average eligible retiree, Social Security will replace about 40% of employment income. As of 2016, the average monthly check is a little over $1,300.
Most financial planners advise clients preparing for a comfortable retirement to replace 80% of their pre-retirement income.
That means you need to make up the difference by saving or investing—or a combination of both.
Social Security was never meant to replace all of a worker’s income. It was primarily instituted to prevent the working poor and non-working widows of male breadwinners from falling into poverty once employment income ceased.
Because of this mission, the Social Security benefit system is skewed in favor of low-wage earners. As the AARP points out, those making around $20,000 for the highest-paid 35 years of their careers will see a 57% replacement rate; higher earners only receive about 35%.
Yet, many pre-retirees don’t realize that Uncle Sam won’t provide a higher retirement benefit.
Last year, AARP published a study showing just how wide the knowledge gap is in persons aged 45–64. As household incomes fall, misconceptions over how much income Social Security will replace increase.
For example, only 5% of those with incomes over $100,000 think Social Security will make up between 80% and 100% of wages. Of those earning less than $50,000, 37% believe that to be true.
Surveys of current retirees highlight how ignorance of pre-retirement income replacement can cause problems later in life.
In Transamerica Center for Retirement Studies’ latest study, 89% of 2,000 retirees said that Social Security made up at least part of their retirement income. The number that expected those benefits to be their main income source through the rest of their retirement: 61%.
With their retirement in full swing, 84% of respondents felt that they hadn’t saved enough for retirement. Nearly three-quarters regretted not saving more while they were working, and 68% wished they had known more about saving and investing for retirement.
Nearly half admitted they should have started preparing for retirement much earlier than they had.
Though the majority of retirees in the Transamerica study considered their retirements happy, a 2015 survey administered by the Employee Benefit Research Institute found that workers with the highest levels of confidence in the success of their own retirement had one thing in common: an actual retirement plan.
What did these plans look like? For 80% of the workers surveyed, Social Security was one income source among many. Respondents listed pensions, Individual Retirement Accounts, investments and personal savings as other streams or sources of income.
A lack of faith in Social Security itself seems to explain mindful planning. Unlike those currently enjoying retirement, workers participating in the study had little confidence that Social Security would provide enough income once they stopped working.
Only 9% believed the system will continue to pay out benefits that meet or exceed those enjoyed by today’s retirees.
Now that you know that Uncle Sam will replace only a portion of your earnings once you retire, how should you plan ahead? Here are a few tips.
Open an IRA
IRAs are efficient ways to save for retirement that also offer sweet tax benefits. If you earn a big paycheck, sock away the maximum amount allowed each year in a traditional account—up to $6,500 if you’re over 50.
Those contributions are deductible: You’ll set aside money for retirement and net savings on your income tax.
Roth IRAs are built with after-tax dollars, but any earnings from the account are tax-free upon withdrawal. Contribution limits for traditional IRAs apply to Roths, too.
Pad your 401(k)
Contributing to an employer-sponsored 401(k) is a win-win, since your company will usually match your pre-tax contribution, up to a certain amount. You also get to choose how the money is invested. And if your company fails, you still get your money.
For public education employees and tax-exempt entities, tax-sheltered annuities called 403(b), are commonly offered. These can be filled with either pre-tax earnings, like a traditional IRA, or after-tax income, like a Roth account.
Invest for Retirement
Investing money wisely doesn’t have to be confusing. Do your research, or consult a financial planner to understand the myriad types of investment products available.
Since you’re investing for retirement, you’ll want to look at costs: Opt for low-expense ratios or fees and no-load funds (you don’t pay for every transaction).
What about risk? If you’re years away from retirement, you’re probably able to withstand more risk than if your retirement date is already on the calendar.
Target-date funds feature a mix of stocks, bonds, and cash equivalents, like any other mutual fund. However, with target-date funds the allocation becomes less weighted in stocks and more in favor of bonds and cash as your target date approaches.
This means higher risk in the early years, which gradually decreases as you move closer to retirement.
For example, Vanguard Target Retirement 2025 Investment Fund (VTTVX) gets a five-star rating from Morningstar, and a low-expense ratio of 0.15%.
The T. Rowe Price Retirement 2025 (TRRHX) is also a good bet. This fund offers below-average fees, fairly low expenses, and Morningstar’s five-star rating.
Another type of mutual fund worth investigating is the index fund, which tracks a specific market index—often the S&P 500. These carry inexpensive fees, since they are passively, rather than actively, managed.
Funds that simply buy the securities of the companies in a particular index also cuts down on “churn,” the buying and selling of assets that can make investors nervous.
Consider the Vanguard 500 Index Fund (VFINX), which has a very low-expense ratio of only 0.05%, and requires only $3,000 to participate.
Feeling brave? Take a look at the Global X SuperDividend ETF (NYSEARCA:SDIV). This fund tracks the 100 highest dividend-yielding stocks in the world, meaning bigger yields—but bigger risk.
Whichever planning route you choose, it’s important to start mapping out a retirement strategy as early as possible.
If you’re eligible for Social Security benefits, Uncle Sam will provide some assistance… but the primary responsibility for a comfortable retirement rests on you.