If you calculate how much you need to save to completely stop working for a 20- or 30-year retirement, you'll likely arrive at a very large number. To produce an annual income of around $40,000 for 30 years, you need to have about $1 million saved. If you need more money than that to maintain your current standard of living, you'll have to save even more. Finding out that you will need to accumulate seven figures to have a modest retirement income is daunting. Here are some strategies to cope with retirement sticker shock:
Break it up into steps. Instead of focusing on the final retirement account balance you hope to accumulate, think about smaller and more immediate financial goals. "If you break it down into smaller segments, it is much more reasonable," says David Peterson, a certified financial planner and president of Peak Capital Investment Services in Highlands Ranch, Colo. "Figure out how much you need to save on a monthly or yearly basis."
Save over many years. If you start saving for retirement at age 25, you can reach $1 million by age 65 by putting away just under $4,000 annually and earning an 8 percent annual return. If you wait until age 40 to start saving, you'll have to tuck away over $13,000 annually to accumulate the same seven-figure nest egg by age 65. "If somebody is working continuously and consistently setting aside 10 percent of their pay in a 401(k) at work or an IRA over a 10- or 20-year time period, they are going to be able to retire with an adequate lifestyle," says Matt Taylor, a certified financial planner and president of Taylor Retirement Services in Harrisburg, Pa.
Boost your contributions over time. Workers with small salaries may not be able to save 10 percent of their paychecks at first. Start small and boost your contributions when you get a raise or bonus, or when you are able to eliminate other expenses from your budget. "I like to refer to saving as paying a retirement bill that is built into your normal budget," says Lynn Mayabb, a certified financial planner and senior managing advisor for BKD Wealth Advisors in Kansas City, Mo. "As you get raises, try to keep increasing the amount you are saving or save a little more when your kids get out of college."
Take advantage of employer help. If your company provides a traditional pension, you can get away with saving much less on your own. Even a 401(k) match can significantly help you to reach your retirement goal. A 25-year-old with an employer 401(k) matching contribution of $1,500 per year could accumulate $1 million for retirement by saving just $2,205 annually, assuming an 8 percent annual return.
Minimize taxes and fees. Calculate whether it is better for you to defer taxes on your retirement savings using a traditional retirement account or to pre-pay some of your taxes using a Roth 401(k) or Roth IRA. Minimizing the taxes you pay on your nest egg will provide more money for spending in retirement. It's also important to choose investments with low expense ratios. Paying even a 1 percent fee on long-term investments could cost you thousands of dollars over your lifetime.
Factor in Social Security. If you've been paying into the Social Security system, you're not saving for retirement completely on your own. Your Social Security payments will get you part of the way there. The average monthly Social Security benefit was $1,180.10 in May 2011. A dual-earner couple each receiving the average benefit would receive $28,322.40 annually, which would be adjusted for inflation each year. To produce $40,000 of annual income, you will only need to save enough to produce another $11,677.60 annually. However, if one member of the couple should pass away, you will receive less from Social Security. Your Social Security benefit will also be raised or lowered based on the date you first sign up for payments. Benefit payments are reduced for people who sign up before their full retirement age, which is typically age 66 or 67. Payouts then increase for each year you delay claiming until age 70. "Every month you wait, you are increasing the dollar amount you will receive permanently," says Mayabb.