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How Much Should You Have in Your 401(k) to Retire?

The question of how much money you need for a comfortable retirement is an ancient one. That’s not really true. In fact, the concept of retirement is a thoroughly modern invention. Before the Industrial Revolution, people worked until they died of injury or old age. Now we have the idea of a retirement age and an end to the working years. (At least for some among us.) However, retirement is a fact of modern life that comes with a host of questions. It’s important to begin answering those questions long before our retirement is in sight.

Chief among those questions is how much do I need in my 401(k) to retire comfortably. To answer that question we have to understand how we got to where we are now, as well as what we should expect when we are ready to retire.

The Beginning of the End

The concept of modern retirement, including the traditional retirement age of 65, was the brainchild of the German Chancellor Otto Von Bismarck in 1889. Bismarck was battling German Marxists for the support of working Germans. He devised a system in which he promised to provide an old-age pension for those who are “disabled from work by age.” The original retirement age of 70 was changed to 65 in 1916. It has pretty much remained there ever since.

The United States adopted its own government sponsored retirement system in 1935 with the creation of Social Security. The Social Security Administration’s reasoning for 65 as the age of retirement is a little more involved. It includes factors such as the few state pensions that were provided had 65 or 70 as their starting point.

More importantly was the fact that 65 was old enough, given life expectancies at the time, to make the system manageable and self-sustaining with only modest levels of taxation. In 1935 age 65 was the beginning of the end of life. Social Security was intended to make it easier.

The End of the Beginning

Retirement has evolved over time to become a more active time of life. Retirement is now viewed as more of an end of the beginning of our lives rather than a beginning of our end. That shift in mindset from sitting around waiting for death to enjoying expanded free time is what drives the need for additional sources of retirement income.

The Employee Benefit Research Institute study on the Expenditure Patterns of Older Americans shows that as we age our expenses decline. Using 65 as their benchmark, they found that household expenses drop by 19 percent by age 75 and 34 percent by age 85. The study also found that people over 50 spend between 40-45 percent of their budget on home and home related items. The bottom line is that by the time we retire our expenses are down between 20 and 40 percent. This is why expert opinions about how much of our pre-retirement income we need. Guidelines generally vary from 60 – 80 percent.

The Big Picture

Is $1 million enough? You may have heard that $1 million is a good goal to save towards in order to ensure a comfortable retirement. Let’s run some numbers.

If when you retire you have a household income of $100,000 and you use the 80 percent income benchmark as your goal, you will need $80,000 a year to maintain your lifestyle. Assuming your 401(k) savings grow at 8% you can expect to have $80,000 a year in interest income without having to touch your principal.

What if your household income at retirement is $200,000 and you only have a million stashed away? Are you really stuck with half of what you will need to retire comfortably?

A study by a group within the National Institutes of Health (NIH) found that roughly 80 percent of seniors owned their own homes. Of those, roughly 55 percent owned them free and clear of debt. The majority of the remainder had very little mortgage and equity debt remaining.

A mortgage-free home can be a source of income from a reverse mortgage. It can also be a safety net so selling the home provides more cash if needed. Social Security, pensions and other annuities also contribute to your retirement income bottom line. So when calculating the amount you need in your 401(k) it is important to consider the big picture of your finances. This means evaluating all of your available assets.

The Bottom Line

It’s important to start saving early in order to plan for retirement. This includes contributing as much as you can in your 401(k). Still but you shouldn’t to rely exclusively on it for retirement. It’s always a good idea to contribute at least enough money to take advantage of your employer’s maximum matching contribution.

Diversifying where you plan to pull your retirement income from can be a smart plan. Having your retirement plan include more than your 401(k) can help protect you from volatility. Imagine you turned 65 and retired a month before the markets crashed in 2008 and all you were counting on for income was your 401(k). Now wipe the sweat off your brow and relax. By now you would have regained most of those losses. Also, you’ve learned a valuable lesson about putting all your eggs in one basket.

Diversify your retirement savings plan as much as possible. This includes doing your best to pay off or at least pay down your home mortgage. When it comes to your 401(k), save as much as you can while still contributing to other sources of retirement income. These other sources can include annuities, pension funds (where applicable), life insurance and other investments.

Tips for Getting Retirement Ready

  • Figure out how much you’ll need to save to retire comfortably.
  • Learn more about what your company offers for retirement options. This includes pensions, automatic 401(k) contributions and employer 401(k) matching.
  • Work with a financial advisor. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. A matching tool like SmartAsset’s can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
Frank Addessi Born and raised in the center of the known universe, Brooklyn NY, and currently hiding out in the bucolic hills of northeast Pennsylvania writing about personal finance. His expertise includes personal loans, credit cards and retirement. It's not easy living the American Dream but someone has to do it!
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