The Importance of Retirement Investment Goals

When you’re making your retirement contributions, are you working toward a specific investment goal in your 401K, IRA and Roth IRA, or are you mostly maximizing your annual contributions as a way of minimizing your tax liability in the current year? The answer to this question is more important than it seems at first glance. While you’re saving and investing money, there should be a target you’re hoping to reach, a certain portfolio size that confirms that you’re on target with your retirement planning. Until you establish such a goal, there’s no objective way to know if you’re adequately funding the kind of retirement you hope to have.

If you haven’t set such a goal up to this point, there are steps you can take to help you establish the amount of money you’ll need to have in your retirement investments to fund the retirement lifestyle you desire. Below we’ll outline the steps, and work an example with the Roth IRA Calculator on this site that can help you set and work toward your own retirement investment goal.

Step One: Determine how much monthly retirement income you’ll need

This step can get really involved, if only because you’re attempting to project expense levels for a life you’re not currently living. To keep it simple, many financial planners recommend using 80% of your pre-retirement income as a convention. For our example, we’ll assume we have a pre-retirement income of $10,000 per month, which at 80% is $8,000.

Step Two: Subtract expected monthly Social Security and pension benefits

You can find this information in your annual Social Security Earnings Record and your company’s human resources department. Subtract these benefits from the monthly retirement income you expect to need, as calculated in Step One. For our example, we’ll assume monthly Social Security and pension income will be $4,000 per month, which reduces the income we’ll need at retirement to $4,000 per month, or $48,000 per year.

Step Three: Factor in time horizons

There are three numbers to be concerned with here, your current age, your expected retirement age, and the number of years you expect to live in retirement. You can use life expectancy charts to determine how long you can be expected to live in retirement, but it can be just as easy to consider the longevity of your family members, and then round up. For our example we’ll assume a current age of 35, an expected retirement at age 65, and that we’ll probably live for 20 years in retirement.

Step Four: Determine the rate of return on investment (ROI) you expect on your retirement assets

Of course there is no way to do this scientifically, but the long term ROI in the stock market is about 8%. You can further expect a lower rate of return on your retirement assets once you retire, since in all probability you’ll have your money in more conservative investments. For our example we’ll assume an ROI—or interest rate--of 8% until retirement, then 4% after retirement.

Step Five: Account for inflation and income taxes

You have to account for the affects of both inflation and income taxes on future income and investments, as they will have a major affect on the outcome of your plans. Fortunately our Roth IRA Calculator does the work for us and automatically accounts for both. It uses a 3.26% annual assumption for inflation, and adjusts the marginal tax rate based on the income figures used.

Step Six: Putting it all together in the Calculator

Now we have our raw numbers:

  1. Needed yearly retirement income, $48,000 (from Step Two above)
  2. Current age, 35, retirement age, 65, and years in retirement, 20 (from Step Three)
  3. Rate of return, or interest rate, during retirement of 4%, and leading up to retirement, 8% (from Step Four)
  4. Annual expected inflation rate, 3.26% (as supplied by the Roth IRA Calculator)
  5. Marginal tax rate (as calculated by the Roth IRA Calculator)

Upon entering the numbers from the first three items above, the Roth IRA Calculator shows that we need to accumulate about $1,728,085 by age 65 in order to provide for the kind of retirement we expect. On the surface an amount exceeding $1.7 million can seem overwhelming, but the calculator indicates:

“That means a monthly contribution of $1,159.51 for Roth, or $1,473.34 for traditional savings (the Roth contributions are lower because there is no tax on withdrawals if you are at least 59 ½ and in the plan for at least 5 years). Watch out though! $1,159.51 monthly exceeds the $5,000 a year Roth IRA contribution limit by $8,914.11!”

As you can see, the Calculator tells us exactly how much we need to put into retirement investments each year over and above the maximum Roth contribution.

PRESTO, now we have a retirement investment goal!

Now we have a goal to shoot for with our retirement investments—a little over $1.7 million. When we make contributions, we’ll know how close we are to reaching our goal, and what steps might be needed to move us up to where we want to be. In fact, we have a long-term goal established—$1.728 million—and an annual contribution goal that gets us to it--$5,000 in a Roth IRA, and $8,914 in other investments, such as a 401k. When you have specific retirement numbers on hand, you’re no longer stashing money into retirement plans just to build up a savings cushion or to avoid taxes. You’re working toward a set goal that will afford you a certain lifestyle by the time you reach retirement age. With that in mind, you’re now better prepared to take on the job of retirement investing. And maybe you’ll work that much harder to turn your retirement dreams into a reality.

Photo by lululemon athletica via Flickr

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