Five Steps to a Financially Secure Retirement
May 25, 2010 — -- Last month, feeling cranky, I unleashed on the dumb money moves people make. Instead of suggesting positive steps to take, I highlighted some of the worst things you can do with your money and why they should be avoided. Glad to get that out of my system.
Now, I'm back to my usual cheerful self and ready to offer up some positive suggestions for the ultimate financial goal -- retirement. Even though it takes decades to reach, retirement has a way of sneaking up on folks. It can be here before you know it -- and before you're ready.
That's why I'd like to suggest five steps you can take to make for a more financially secure retirement. I'm sure you've heard much of this before, but there are some things you can't repeat often enough.
1. Pick a date: This is the date each year when you're going to increase your contribution to a 401(k) or some other retirement savings plan. It could be any day at all: your birthday, wedding anniversary or favorite holiday. Another logical choice is when you expect an annual pay raise.
It doesn't matter. All that matters is that at least once a year you bump up your retirement savings rate by a small amount. The typical recommendation is to increase your savings rate by 1 percent of your gross pay each year. If you're the aggressive type, make it 2 percentage points each year.
Doing it this way should make the reduction in take-home pay barely noticeable; yet at the same time give a nice boost to your retirement savings.
Imagine you make $50,000 a year now and contribute 5 percent of that amount to your 401(k) plan at work. Following the 1-percentage-point-a-year strategy, you will boost your contribution from $2,500 a year to more than $5,000 within five years, assuming you receive pay raises along the way. Within 10 years, you would be contributing more than $7,500.
Over 25 years, that extra $5,000 a year could mean an additional $316,000 in retirement savings, assuming a 7-percent annual rate of return.
2. Do the pay-off math: Calculate what it will take to ensure that you retire mortgage-free. Rather than sticking to the payment schedule provided when you took our your loan, figure out what kind of monthly payments it will take to ensure that your loan balance is $0 on the day you retire.
Suppose you just took out a $250,000, 30-year fixed-rate mortgage at 5 percent. Your monthly payment would be $1,342. But if you plan to retire in 20 years -- not 30 -- then adding an extra $308 to your monthly principal payment will ensure your home is paid off in time for retirement, and reduce your annual income needs by about $16,000.
