Rethink your retirement plan

In December and January, The Simple Dollar is posting a daily series focusing on specific activities you can do right now to set the stage for a great 2011. Out with the old, in with the new.

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How well invested are you for your retirement? Starting is the most important thing, though smart investing always helps. But simply getting in the habit of socking money away each month is the single biggest step towards retirement.

8. Rethink your retirement plan.

If I’ve done one thing right with my personal finances since reaching adulthood, it’s been taking care of my retirement. I’ve consistently put a significant amount away for that future day when I no longer work and I’m ahead of the retirement curve for my age in almost every way you could measure it.

Having said that, of course, I’m in the huge minority there. Many people my age have scarcely thought about retirement. I regularly get emails from readers in their forties and even in their fifties that are just now beginning to think about retirement savings.

That’s a bad idea. Regardless of your age, the sooner you get started with retirement savings, the better. The more years you give yourself to save before retirement, the less you have to take out of each paycheck for retirement.

Getting a grip on your retirement plan really boils down to answering three questions.

Where are you at right now?
The first step is to understand what retirement savings you have built up right now and, to a lesser extent, what types of investments that money is held in.

Make a list of all of your financial accounts and their balances. This will, of course, require you to dig out all of those statements and log into your online accounts to retrieve this information (unless you’re using something like Quicken).

The purpose here is simply to get a grasp of the totality of your retirement savings. You need to know what you have before you can plan intelligently for the future.

Where do you need to be?
Once you have this information in front of you, you can use a retirement planning tool like this one at MSN to get an estimate of what you will actually need at retirement.

Personally, I find such software to be fairly good at giving you a starting point for your calculations, but almost every time, they tend to underestimate what you’ll actually need to do to get there.

Why? They tend to assume a very mundane rate of inflation while also assuming a more-than-healthy return on a diversified investment portfolio. If you know of a retirement portfolio that’s guaranteed to return even 7% over the next 30 years, I’d love to see it.

So why do I encourage people to use such software? First of all, you don’t have to use the default numbers they give you. Most people plug and chug with the default numbers at MSN, which suggests a 9% return on investment. Turn that down to at least 5%, if not lower.

Remember, it’s not a bad thing to save too much for retirement, but it is a very bad thing to not save enough for retirement. You can always retire a bit earlier or live a very robust retirement, but you don’t want to find yourself at age seventy or so without any ability to retire.

How do you get there?
So, how do you get from here to there? The retirement planning tool will give you a suggested amount for annual savings, and you should use that as a bare minimum.

Where do you save that amount, though? You’ll hear a lot of people tossing around suggestions of Roth IRAs and 401(k)s, but here’s the real truth: 99% of the worry about retirement savings is just simply doing the saving, regardless of where you put it. Compared to the concern of not banking nearly enough for retirement, the issue of having a Roth IRA or a 401(k) pales in comparison.

My rule of thumb for most wage earners is if you’re eligible, open a Roth IRA with some brokerage (I use Vanguard, but do your own research). This lets you be completely in control of the account. Also, money in a Roth IRA can be withdrawn at retirement age without any taxation at all, which is a nice perk, but the drawback is that you’ll be funding it with after-tax dollars – meaning the money comes directly from your paycheck. I usually recommend a Roth because I believe taxes will inevitably have to go up from where they’re at right now.

If you don’t know what to invest in among all of your choices, choose a “target retirement” fund that matches when you expect to retire. These investments will automatically balance your money for you, ensuring that you won’t be completely exposed to stocks close to retirement age (so that a big downturn like 2008 won’t sink you), but also gives you a great chance for growth now, when you’re young.

Regardless, the important thing is that you’re saving an appropriate amount. That’s the real key here. Today is the day to get started, if you haven’t already.

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