Photo: Robert Trachtenberg
Saving for Retirement
Q: I'm in my early 60s and earn $2,000 a month from part-time work and Social Security. I rent my home, own my car, and have no debt, but I have just $3,000 in savings. I'd like to begin making monthly contributions of $250 to catch up on my retirement funds. Should I buy an annuity, a Roth IRA, or a regular IRA?
A: While it's never too soon to plan for retirement, a late start is better than none. At this point, a Roth IRA will give you the most flexibility: You can always withdraw money you contribute without penalty or tax.
Let's assume your Roth IRA earns 4 percent a year. (People in their 60s should keep no more than 40 percent of their long-term investments in stocks to limit their exposure to market risk.) If you contribute $250 a month, you could save approximately $37,000 in just ten years. In your situation, that would be a great achievement. To ensure that money could help support you for the rest of your life, plan to withdraw no more than 5 percent a year. (That works out to $1,850 in the first year you're fully retired.)
I think it's great to focus on setting money aside, but there's an even better way to prepare for retirement: Reduce your expenses. If you live in a pricey area, consider moving to a smaller home (as long as relocation costs don't exceed any potential savings on rent or utilities) or perhaps getting a roommate. Sharing your space can not only improve your financial situation but also—if you find a great roomie—provide an emotional boost.
In addition, you may want to suspend your Social Security benefits and restart them when you're older. (You're allowed this one-time mulligan only if you began taking benefits within the past year.) Since you're younger than 66, which I presume is your full retirement age, you're collecting less than 100 percent of the benefit you're entitled to. While you would have to repay money you've already received, in less than four years your benefits could grow by 25 percent. You can't earn a return that high on another investment without taking on a lot of risk.
Q. I am a 45-year-old single woman with no children. I make $155,000 a year, have $165,000 in savings and $125,000 in a 401(k), and owe nothing other than my mortgage (14 years left on a $240,000 loan at 3.5 percent). What's the best way to make my dream of retiring in ten years come true?
A. My advice is to modify your dream right now. You simply don't have enough set aside in retirement savings to stop working as soon as you'd like. Let's say the $125,000 that you have in your 401(k) grows at an annualized 6 percent rate and you manage to add $15,000 a year to it—that's just 10 percent of your salary—you could save about $430,000 over the next decade. I know that sounds like a lot, but those funds might have to last you for at least 30 years. And that's not because I'm suggesting you're going to be an old-age outlier; the average life expectancy for a 55-year-old woman today is 83.
In the first year of retirement, you should plan to withdraw no more than 4 percent of your total funds. (You can adjust that sum for inflation in subsequent years, but even that rate is pretty aggressive for someone planning to retire at such a young age.) Four percent of $430,000 is $17,200. But because a withdrawal from a traditional 401(k) is taxed as ordinary income, you might net $13,000. That's less than $1,100 a month, and I doubt that's enough for you to live on, even if you're frugal. So let's say we shift half your current savings into investments on the assumption that $82,500 is an adequate amount for your emergency fund; that's still not enough money for you to retire comfortably. I know you don't like hearing that you'll need to work until 67 or 70, but better to hear it now than to realize you've made a big mistake later.
If you save diligently over the next 17 years and withdrawing 4 percent a year (adjusted annually for inflation) generates enough cash for you, you may be able to retire early—at age 62. (Use the free retirement income calculator at troweprice.com/ric to analyze your options.) Even though you will be eligible for Social Security at that time, think seriously about delaying your benefits until at least 67, when your payout could be 30 percent higher. Consider working part-time—or better yet, full-time—for a few years to supplement your income until the checks arrive.
Next: Determining the right amount to save up for your retirement