THANKS TO THE PROLIFERATION of online calculators, it’s now possible for ordinary investors to piece together their own lifetime financial plan. Want a roadmap to guide you through the years ahead? Check out the 18 steps below. Depending on your situation and how much financial progress you have already made, some steps may be unnecessary.
1. Estimate your retirement income needs. One rule of thumb says that, once retired, you need 80% of your final salary to be financially comfortable. But you might be fine with less if you’re a prodigious saver who regularly socks away 20% of income, rather than the often recommended 10%. You might also make do with less if, by retirement, your mortgage is paid off and the children are off the family payroll.
2. Get a handle on Social Security and pension income. If you are entitled to a traditional employer pension, check the latest benefits statement from your employer or contact human resources. Meanwhile, to find out how much you might receive from Social Security, go to SocialSecurity.gov and click through to the Retirement Estimator. If you’re unable to use that calculator, try the Quick Calculator, also available at SocialSecurity.gov.
3. Set a goal for your retirement nest egg. Take your answer from Step No. 1 and subtract the sums from Step No. 2. Let’s say you will need $50,000 a year to retire in comfort and you’ll receive $20,000 from Social Security and nothing from an employer’s pension plan. That leaves $30,000 a year that will need to come from savings. To generate that income using a 4% portfolio withdrawal rate, how much would you need to save by retirement? If you divide $30,000 by 0.04 (or, alternatively, multiply by 25), you’ll get your answer: $750,000.
4. Calculate required monthly savings. To find out how much you need to save each month to amass your target retirement nest egg, use the Savings Goals calculator at Dinkytown.net. Err on the conservative side by plugging in a 4% annual return and 2% for inflation.
5. Design your portfolio. Your investment return will depend on your basic mix of stocks and more conservative investments. To get some guidance on what mix you ought to hold, try the Investor Questionnaire at Vanguard.com.
6. Prepare for financial emergencies. Get your latest pay stub and see how much you take home each month, after taxes and any retirement-plan contributions are deducted. From that sum, subtract any additional monthly savings. That should give you a reasonable estimate of your typical monthly spending.
Experts often suggest holding an emergency fund equal to between three and six months of living expenses. Go for the full six months if your job is tenuous or you’re self-employed. Opt for a smaller amount if your position is more secure, your spouse also works, you have a home-equity line of credit or you have other savings in a regular taxable account.
7. Plug holes in your insurance coverage. There are seven types of insurance you potentially need: health, life, disability, long-term care, homeowner’s, auto and umbrella liability. Here are some rough-and-ready rules.
Everybody should have health insurance, and you also need auto and homeowner’s insurance if you own a car and a house. If you have less than $1 million in savings, you should probably have disability insurance if you’re still in the workforce, and also life insurance if you have children still at home or a spouse who doesn’t work. If you are approaching retirement and you have between $300,000 and $1 million in savings, consider buying some form of long-term-care insurance.
What if you have more than $1 million in savings? You can probably afford to self-insure for disability, life and long-term care. But consider getting umbrella liability insurance, in case you’re sued.
8. Decide how much house you can afford. Banks typically want borrowers to limit their monthly mortgage payments, including property taxes and homeowner’s insurance, to 28% of their pretax monthly income. What does that mean in terms of house size? Try the calculator labeled “How Much House Can I Afford?” at HSH.com.
9. Estimate college costs. Roughly speaking, it costs $20,000 a year for a state university, $40,000 for the typical private college and $65,000 for an elite private college. Make your choice, multiply by four and you’ll have the cost to send each of your children to college for four years.
10. Check financial aid eligibility. To get a handle on how much college aid you might receive, try the EFC Calculator at CollegeBoard.org. The calculator will give an estimate of your “expected family contribution”—how much you’ll have to cough up for college costs each year. Colleges should then provide enough aid to cover the difference between your contribution and the college’s annual cost.
11. Calculate your college fund’s potential growth. If you won’t receive much aid—and hence your expected family contribution is large—it probably makes sense to sock away some money for college. To find out how much you might amass by the time your children turn age 18, return to Dinkytown.net and use the Savings Goals calculator. Again, be cautious, opting for a 4% annual return and 2% for inflation.
12. Find a 529 college savings plan. These plans are typically the best bet for college savers. Check out your choices at SavingforCollege.com.
13. Aim to retire debt-free. Probably the biggest debt you need to eliminate is your mortgage. If your home loan won’t be paid off until after your expected retirement date, consider making extra-principal payments. To figure out how much you need to add to each monthly mortgage check, use the Mortgage Calculator at Bankrate.com.
14. Decide when to claim Social Security. You’ll need to grapple with this issue as you approach retirement age. Often, the smart strategy is to delay benefits until age 70 if you’re single. What if you’re married? The spouse with the highest lifetime earnings should typically postpone benefits until 70, while the other spouse might claim benefits earlier. For further help, check out UnitedCapital.com’s Social Security calculator.
15. Consider an income annuity. To supplement the income you’ll receive from Social Security, you might purchase an annuity that pays lifetime income. How much income will you receive? Try the Guaranteed Income Estimator at Fidelity.com/gie.
16. Refine your retirement strategy. Social Security, together with any pension and annuity income, should provide you with a steady stream of retirement income. For additional spending money, you’ll have your retirement savings, which you might draw down using a 4% withdrawal rate.
Those withdrawals, however, could run smack into a major market downturn. As a precaution, keep a sum equal to five years of portfolio withdrawals in money-market funds, savings accounts and other cash investments, which you can then draw on during rough spells for stocks and bonds. Also consider which expenses you would cut, should the market downturn prove to be especially severe.
17. Tap into home equity. Early in retirement, you might trade down to a smaller home, thereby reducing your monthly costs and freeing up home equity, which you can then add to your retirement savings. Later in retirement, if you start to run out of savings, you might consider a reverse mortgage. To see how much cash that might provide, head to ReverseMortgage.org and play around with the site’s calculator.
18. Give some thought to your heirs. Estate planning can involve all kinds of legal documents and complicated strategies. But three steps are essential: Make sure you have a will, the right beneficiaries listed on your retirement accounts and the right beneficiaries named on your life insurance.
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