I wanted to touch on two important topics briefly today, starting with the question of how much your employees need to save to successfully retire. We’ll then address the ‘Rule of 72,’ which gives you the ability to figure out how long it will take for your investments to double in value, as well how long it will take social security to eat into your spending power.
In general, we tell people you need to save 10% to retire. It’s a little more complicated than that though because you need to figure out what percentage of your current income you need. We call this the ‘income replacement ratio’ or ‘income replacement formula.’
As a hypothetical scenario, let’s say we had a 40-year-old worker who makes $50,000 a year and knows he wants to retire at 66. It sounds simple to just say he needs 80% of his income—$40,000—but you have to consider inflation. Inflation chews into your spending power. We know we have inflation to battle against, but how?
This is where the Rule of 72 comes in. We can use this rule to engineer what your retirement needs to look like in the future. For the purpose of this example, let’s say our national average inflation rate was 3%. We’d then take 72 and divide by that three, giving us 24. This tells us that in 24 years, your spending power would be cut in half. If we go back to our 40-year-old who wants to retire in 26 years, he would need $80,000, not $40,000.
Now, you might be thinking that this sounds too complicated and that your employees would never be able to figure it out. However, most 401(k) providers will do the calculations that will tell you how much income you’ll be able to replace. Some will even take that lump sum and turn it into a monthly income. If you’d like a list of these providers, I’d be happy to provide you one.
This is mission critical. If your employees don’t know what they need to save for retirement, they are going to arrive at a point where they don’t have enough money to fund their retirement. This sounds like it can get difficult, but we provide a service to our clients called a ‘gap analysis.’ This takes a look at what you have in your plan, what you’re saving, and how it gets you to your retirement.
If you’d like a sample report of the gap analysis or you have any questions for us, give us a call. We would love to hear from you.