Scenario 1: Your path to retirement is wide, gently sloped, paved with good intentions and free of potholes—including market declines, job loss and health problems.
Scenario 2: Your path to retirement is steep, littered with obstacles and fraught with perils, including procrastination and the temptation to raid your accounts to finance other pressing priorities.
Unfortunately, scenario number two is more likely. In a new survey by Ameriprise Financial of people ages 50 to 70, virtually all of the respondents said they had experienced at least one retirement derailer, and more than half said that it had seriously affected their retirement savings. The average amount lost or forgone: $117,000. A poll of Kiplinger's readers showed similar results.
You can't stop life from knocking you off your feet, but you can plan for the unexpected and move forward after the inevitable hard knocks. "How you got to where you are to some degree doesn't matter," says Stuart Ritter, a financial planner and vice-president of T. Rowe Price Investment Services. "You need to think about where you are today and make a plan that will get you where you need to be."
Saving too little
One of the biggest threats to retirement security? Skimping on the amount you save each month. For the best chance of maintaining your lifestyle in retirement, aim to contribute 15% of your salary, including any employer match, to your 401(k) or other savings account throughout your career (see What's Your Retirement Number?). Most people fall short of that benchmark. The average employee contribution to a 401(k) is 6% to 8%.
Ironically, your company may be encouraging you to save small even as it encourages you to save at all. Close to half of employers who have 401(k) plans automatically enroll employees in the accounts, typically setting the contribution level at 3%. That's enough to get you started but not enough to build a big nest egg. Says Ritter: "Saving 3% in a retirement account is like going to the gym for six minutes."
Saving 15% may seem like lifting weights at the gym for several hours. Try it anyway, says Ritter. "Kick your contribution level up to 15% for three months. At the end of the three months, you can lower it, if necessary." But rather than dipping back to single digits, go with 10% or 12%, he says. "People find they can settle on a much higher amount than they were contributing before."
Starting too late
Procrastination is another risk: With each year you neglect to save, you lose an opportunity to fuel your accounts and to let compounding keep the momentum going. Say you're 25, you earn $40,000 a year and contribute 13% of your salary annually, including the company match. At that pace, you would accumulate a stash of almost $500,000 (in today's dollars) by age 65, according to an example by T. Rowe Price (the calculation assumes a 3% annual raise and a 7% annualized return, discounted by 3% annual inflation). If you wait until age 30 to start saving, you would have to set aside 17% of your salary annually to arrive at the same amount. The longer you wait, the higher the number becomes.
So powerful is the effect of saving early that you could have less trouble catching up if you take a several-year break—say, to pay for college—than if you wait until midlife to start. At that point, says George Middleton, a financial adviser in Vancouver, Wash., "the amount of money you have to put away can be ungodly."
Still, you can make headway, especially if your kids are grown and you have fewer expenses. Say you're 55, earn $80,000 a year and have nothing saved for retirement. You put the pedal to the metal by setting aside $23,000 in your 401(k) each year for the next ten years. That $23,000 combines the annual maximum for people younger than 50 ($17,500 in 2013) plus the annual catch-up amount for people 50 and older ($5,500). If your employer matches 3% on the first 6% of pay and your investments earn an annualized 7%, you'd amass $434,700 by the time you reached 65.
Shying away from stocks
Given the devastating bear market of 2007–09, it's no surprise that more than half of respondents in the Ameriprise survey said the downturn had negatively affected their retirement savings. But the resounding comeback since then means that "most people who were in the market regained those assets if they didn't sell everything off," says Suzanna de Baca, vice-president of wealth strategies at Ameriprise Financial.
That's a big if. For some investors, a bad case of the jitters became a bigger derailer than the recession itself (see How to Learn to Love [Stocks] Again). "People got very nervous and became more conservative, so when the market came back up, they had less of their portfolio participating in the rally," says de Baca. Not only did they lose the potential for growth, but they stayed out too long.
If you're among those who bailed on the market and balked at reentry, you can get back in (and stay in) by investing in stocks or stock mutual funds in set amounts on a regular basis. Using this strategy, known as dollar-cost averaging, you automatically buy more shares at lower prices and fewer shares at higher prices—an antidote to market-driven decisions to buy when stocks are high and sell in a panic at market lows. Once you decide on your mix of investments, use automatic rebalancing to keep it that way, advises Debbie Grose, of Lighthouse Financial Planning, in Folsom, Cal. "Rebalancing forces you to sell high and buy low. It takes the emotion out of it."
Most financial planners recommend that your portfolio be at least 80% in stocks in your twenties, gradually shifting to, say, 50% stocks and 50% fixed-income investments as you approach retirement. But formulas don't cure panic attacks. "Set your risk at the level you're willing to withstand in a downturn," says Middleton. "If you freaked and sold out in 2008, you'll have to set the level very low so that you won't do it again."
Putting college first
Amassing hundreds of thousands of dollars for retirement is challenge enough, but parents are also expected to save $80,000 to $100,000 per kid to cover the college bills. In fact, half of parents don't save for college at all, and the average savings among those who do runs about $12,000, according to a 2013 report by Sallie Mae, the financial services institution. Faced with a shortfall, two-thirds of families say they would use their retirement savings to pay for their children's college education, if necessary.
"Parents see how hard their child has worked and want to give him that opportunity. The ability to say no becomes an issue," says Fred Amrein, a registered financial adviser in Wynnewood, Pa., who specializes in college and retirement planning. Don't wait until your kid is 17 to discuss how much you'll contribute. Have a conversation early about how much you can afford to give, says Amrein.
A Roth IRA can be one way to save for both college and retirement, although it won't get you all the way to either goal. You can contribute up to $5,500 a year ($6,500 if you're 50 or older) in after-tax dollars, and the money grows tax-free. You can withdraw your contributions for any reason, including college, without owing tax on the distribution. You will pay taxes on the earnings (unless you're 59 1/2 or older and have had the account for at least five calendar years), but you won't have to pay a 10% early-withdrawal penalty if you use the money for qualified higher-education expenses.
Keep in mind that if you use money from the Roth for college, there will be less of it for your old age. Plus, the closer you are to retirement when your kids get out of college, the fewer years you have to catch up. Unless you've saved a bundle for retirement in a 401(k), which sets a much higher annual maximum for contributions ($17,500 in 2013, or $23,000 if you're 50 or older), let the money in the Roth grow. "Your savings are the number-one way of funding retirement. Do that first," says Ritter.
Losing a job
Leaving the workforce, even temporarily, deprives you of current income and makes it tougher than ever to save for retirement. You might even find yourself tapping your retirement accounts to cover day-to-day expenses. You'll owe taxes on distributions from a traditional IRA plus a 10% penalty if you're younger than 59 1/2.
The best way to avoid that dismal situation is to have an emergency reserve that covers at least six months or even a year of living expenses, says Jim Holtzman, a certified financial planner in Pittsburgh. He acknowledges, however, that "that's easy to recommend and hard to implement." Avoid further disaster by hanging on to health insurance: If you can't get coverage through your spouse, look into keeping your employer-based coverage through COBRA. You can extend that coverage for up to 18 months, although you'll pay the full premium plus a small administrative fee. As of January 2014, you'll also have access to coverage through state health exchanges.
Losing a spouse
Married couples who depend on each other's earning power need life insurance to cover the gaps when one spouse dies. You can get a rough idea of how much coverage you'll need on each life by calculating what you each contribute to annual living expenses and multiplying that amount by the number of years you expect to need it, says Steve Vernon, of Rest-of-Life Communications, a retirement consulting firm. (For advice on how to do a more precise calculation, see "How Much Life Insurance Do You Need?".)
If you have a pension, you'll have the option of choosing a single-life benefit, which ends at your death, or the standard joint and survivor's benefit, which pays less while you're alive but keeps paying (typically at 50% to 75% of the benefit) for the rest of your spouse's life. Your spouse is legally entitled to the survivor's benefit and must sign a waiver to forgo it. Don't be tempted by the higher-paying single-life option if your spouse will need the survivor's benefit later.
Decisions you make in claiming Social Security are similarly key. If you're the higher earner (typically, the man), "you will really help your spouse by delaying Social Security as long as possible," says Vernon. The benefit grows by about 6.5% to 8% a year for each year you delay after age 62, when you first qualify, until you reach age 70. If you die first, your spouse can qualify for a survivor's benefit up to the full amount you were entitled to, depending on the age at which she files.