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The Short Answer

12 Questions to Ask When Saving for Retirement

Knowing how much to sock away for your golden years requires understanding these variables.

Question: I'm still decades away from retirement but don't really have a good handle on how much I need to save. I put money aside each month, but how do I know if it's enough?

Answer: Getting a handle on how much you'll need for retirement is one of the most common--and most important--financial challenges facing those of us who are still working. For people like you, with many years left before retirement, and even for those who are much closer to it, trying to figure out whether they are saving enough to live comfortably on once their working days are over can be daunting.

It's a calculation involving many variables, some within your control, some not. In this recent article by Christine Benz, Morningstar's director of personal finance, she discusses some of the swing factors that come into play when estimating how much income you'll need in retirement. Determining whether you're saving enough now is another important piece of the puzzle.

The Web offers an abundance of retirement savings calculators of varying quality and precision to help you on your way. Morningstar offers its own here, and it is based on an in-depth study by Morningstar's Ibbotson Associates which focused on savings rates for various age and income groups. These calculators typically rely on assumptions of one kind or another--about stock market performance or the rate of inflation, for example. By trying out a few of these calculators you can get a general idea of how much you should be saving. But results can vary wildly based on differing assumptions and methodologies.

Below is a list of questions to ask as part of your retirement-savings calculation. As a starting point, you may want to use a basic rule of thumb for your savings rate. For example, for many years financial planners suggested workers set aside 10% of pay for retirement. But with the stock market's lackluster performance during the past decade and pension plans becoming rarer, many now use 15% as a starting point. Another option is to use an online calculator to come up with a result more specific to your own situation. As you go through the questions you'll see notes about how your answer might affect your required savings rate. Keep in mind that this list is not comprehensive, nor are all questions of equal importance. Tallying up your responses won't give you a specific answer about how much you need to save for retirement. However, it should get you thinking about whether you need to save more than you currently are, or whether you can afford to hold things steady or even ease up a little.

How long do you plan to work?
The longer you work, the more time you have to save for retirement and the shorter the amount of time your retirement savings needs to cover. In fact, according to a recent study by the Center for Retirement Research at Boston College, about one fourth of all households who lack the resources to retire at age 65 while still maintaining their current standard of living could afford to retire after working an extra one to three years. Part of the reason is that working longer would allow them to delay taking Social Security, which increases benefits at a rate of about 8% per year up to age 70. But don't assume working into your late 60s or beyond is a given. As this Short Answer article explains, many people who expect to work beyond 65 find they are unable to do so. 

You may need to save more:
If you hope to retire early or want to avoid having to work in retirement, or if you have a health condition that could interfere with your ability to work later in life.

You may not need to save as much:
If you are confident that you will be able to work well past traditional retirement age--for example if you are self-employed or have excellent long-term job security and your health is good.

How much have you already saved?
Naturally, the more you have saved the better your retirement picture will be, especially if you still have many years to go before retirement. For late-starters, however, there is still time to close the gap by saving as much as possible. 

You may need to save more: 
If you've been lax in saving and need to play catch-up.

You may not need to save as much:
If you know you've already got more than enough for retirement and prefer to spend more of your income on present-day needs.

What is your current income level?
Most retirement savings guidelines aim to build a nest egg that allows the saver to maintain his or her lifestyle in retirement. But for high-income workers, that might mean saving a higher percentage of income than it does for lower-income workers. That's because for lower-income workers Social Security provides a greater percentage of the replacement income they need in retirement. But because Social Security benefits are capped (at $2,513 a month for 2012), those requiring considerably more than that per month will need to save more to maintain their standard of living. On the other hand, low-income workers also have less margin for error in projecting retirement-income needs because they tend to have less discretionary spending to cut back on, as Benz's article explains.

You may need to save more:
If you expect that you will need considerably more than Social Security provides to maintain your standard of living.

You may not need to save as much:
If you are
confident that Social Security and your retirement savings will be sufficient to maintain your lifestyle.

Will you receive a pension?
As with Social Security, a pension can provide insurance against the risk of outliving your money. As a source of guaranteed income for life, a pension helps offset the need to generate income from other retirement assets.

You may need to save more:
If you do not have a pension and must rely solely on your investments and Social Security for retirement income.

You may not need to save as much:
If you expect to get a pension that will provide enough monthly income to reduce your need to rely on other investment types. Extra credit if your pension is inflation-adjusted. 

What sort of lifestyle do you expect to have in retirement?
Do you expect to live the way you do today, or do you plan to travel more? Will downsizing your home be an option? The scope of your retirement dreams helps dictate how much you will need to achieve them.

You may need to save more:
If you think your expenses will stay the same or increase in retirement.

You may not need to save as much:
If you think you'll spend considerably less in retirement, perhaps by moving to a smaller home, or by spending less on things such as entertainment and dining out.

What is your risk tolerance?
Risk tolerance--the amount of risk you feel you can handle--will help determine how your retirement accounts perform and thus how much you're likely to have once you stop working. Nervous about stocks? You may prefer to tilt your savings toward safer asset classes such as bonds, but you'll need to save more than you would with stocks, which historically have outperformed bonds over long periods. 

You may need to save more:
If retirement is many years away but you'd rather stick with safer investments than ride the stock roller coaster.

You may not need to save as much:
If you are willing to accept the higher risk/higher reward profile associated with equities.

How much equity exposure do you plan to have in retirement?
If you plan to keep most of your savings in low-risk asset classes such as bonds and certificates of deposit in retirement, you run the risk of having your portfolio's spending power eroded by inflation. Investing in stocks might help keep inflation at bay, but it also adds risk and could result in your losing a good chunk of your savings if the market tanks.

You may need to save more:
If you plan to invest primarily in fixed-income vehicles in retirement.

You may not need to save as much:
If you plan to invest a substantial portion of your savings in stocks even after you retire.

What are your expectations for inflation?
As discussed in this article, inflation can diminish the spending power of a retirement portfolio. A retirement account that averages 10% gains over a decade sounds pretty good. But if inflation averages 5% over that time span, it effectively cuts that gain in half. The more you save now, the better prepared you'll be later should inflation rear its ugly head.

You may need to save more:
If you are concerned that inflation could cut into your gains down the road.

You may not need to save as much:
If you are saving at least enough to keep up with the historic rate of inflation (about 3%).

What is your life expectancy based on family/personal history?
For those in good health and with family histories of longevity, planning for a lengthy retirement is necessary to minimize the risk of outliving savings. Those with good reason to believe they won't live as long in retirement still need to save, though not as much.

You may need to save more:
If you have a family history of longevity.

You may not need to save as much:
If you are in ill health
or come from a family in which longevity is rare.

Do you want to leave money to heirs or charity? 
For some people, leaving a financial legacy is a priority. For others, it's not that important, and they'd just assume take care of their own needs before worrying about leaving assets behind. 

You may need to save more:
If leaving an inheritance or bequest to charity is important to you.

You may not need to save as much:
If you plan to spend it all yourself.

Does your employer offer a company match?
It's usually a no-brainer for workers to contribute enough to their company-sponsored retirement plans to get the match. But the size of that match can dictate how much they need to contribute. If a worker needs to save 15% of her current salary for retirement and her company offers to match her dollar-for-dollar on the first 5%, that means she only needs to set aside 10% from her paycheck. But if the company match is less--say, 2%--that amount climbs to 13%.

You may need to save more:
If your company offers a small match or no match at all.

You may not need to save as much:
If your combined company match and personal contribution meets or exceeds what you think you need to save.

Are your retirement savings in a Roth? 
Don't overlook the impact taxes will have on your retirement account distributions. Remember that tax break you got by investing in a traditional IRA or 401(k)? Once you are retired those distributions finally will be taxed, and at regular income rates. Not so for a Roth IRA or Roth 401(k), which don't give you a tax break today, but which do provide tax-free growth and distributions later. That means that a Roth account could provide you with thousands of dollars in extra disposable income per year in retirement. 

You may need to save more:
If the bulk of your retirement assets is in traditional retirement accounts that will be taxed upon distribution. (For more on this topic, see this article.) 

You may not need to save as much:
If the bulk of your retirement savings is in Roth accounts.

Now that you've read through and thought about the many issues at play in calculating how much you need to save for retirement, it's time to apply your answers to these questions. Whether you do the calculation yourself, use an online retirement calculator, or hire someone to crunch the numbers for you, there's no time like the present to put a carefully considered retirement strategy in action.

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