Limits are not answers

Many times folks are proud that they have been contributing the maximum to their IRAs, but when I look at their statements, I’ll see that they are contributing $2000 or $4000, or some other number that was the annual contribution limit….years ago. It’s news to some folks that  the limit is $5500; and if you are 50 or older it’s $6500 per year. This is one way focusing on a limit, can, well, limit you.

Take the IRA. A lot of folks’ retirement savings consists of maxing out their IRA each year. That is a good thing. But is it enough? Maybe. Others will look to a 401(k) plan offered by their employer. If the employer will match every employee contribution with 50-cents up to the first 5% of income, guess how much most employees put in? That’s right, 5%. That is a good thing…getting free money certainly is not bad. But is it enough?

Let’s look at an example. Say there is a couple who are both 40-years-old. They don’t have much in the way of savings, and would like to retire at age 65. One of them earns $60,000 and the other $30,000 each year. We’ll assume they are eligible for normal social security benefits.

I took that question and entered the variables into the Retirement Income Calculator available (for free) at www.TRowePrice.com. I had to feed in some investment mixes and assumptions (trust me on those, I’m a professional). As is common nowadays, I didn’t add a pension.

According to the calculator our couple would need $5625 per month at retirement (in this case, T. Rowe Price had to make some assumptions – we’ll trust them). Unfortunately the couple will only be bringing in $2634 from Social Security. Oh, but wait, what about our 401(k) and IRAs?

I fed in a 10% total contribution to the 401(k) for the larger wage-earner (employee + employer contributions) and $6500 each into an IRA. That did well, but not well enough. I fed in a 10% total contribution to the 401(k) for the larger wage-earner (employee + employer contributions) and $6500 each into an IRA to mimic what they would do during their working years. That got them closer to their retirement goal, but only to $4761 per month of projected income. That’s not shabby, but it’s not going to provide the retirement that matches their current standard of living.

The calculator allowed me to tweak on things and there were a number “ifs” that could “fix” the problem. If they started earlier than age 40. If they put more into their 401(k) or another account.  If they retired later. They could invest a bit more aggressively. They could reduce their in-retirement expenses. But all of this would require our couple to actually know they had a problem. That’s rare.

Surveys still show that the average person saving for retirement uses guessing as the method of determining if they are investing enough money. And many of those guessers “guess” that filling up their IRAs, getting the match on their 401(k), and other good habits equal a good retirement.

It might. But does that guess give you the answer you want for your future?

This article was published under the title "Save, save a lot for retirement"

in the Wichita Falls Times Record News on May 4, 2014.