More. That’s the short answer to “How much should I be saving for retirement?” You could immediately tell me if you are able to break-dance. Could you immediately tell me your break-even savings rate?

Most of us have heard the doom and gloom surrounding the pitiful national savings rate, disappearance of pensions, and evaporating supplemental Social Security payments. Let’s not even mention the changing job environment and our national attachment to easy credit (and its damaging effects on long-term financial security)…

Naturally the question turns to what measures an individual can do to prepare for the future. Answer: save and invest more than you are currently, and assume you can do better. Refer to this Geezeo article and calculator if you’re wondering exactly how much you should be saving for your retirement.

An important part of retirement planning is to figure out your “Break-Even Rate of Return”. To get ahead you must earn more than the amount lost through inflation and taxes.

Here’s a net return on $100. The conditions are:

5% interest earnings
4% inflation, and
a 35% tax bracket (that’s 28% federal + 7% state).

The following example comes from the book “Left-Brain Finance for Right-Brain People” (268):

If $100 earns 5% interest, at the end of the year it is worth $105. That $5 is fully taxed. In the 35% tax bracket you will pay $1.75, which leaves a net earning of $3.25, or a total of $103.25. The 4% inflation rate then reduces the purchasing power of $103.25 to $99.12. In other words, the $100 that grew by $5.00 in one year is worth $99 at year’s end after inflation and taxes take their bite.

Your dollars shrink every year that they don’t break even.

Here’s the formula to figure out your break-even rate of return:

Inflation Rate
————————
(100) - (Tax Bracket) = Break-Even Rate of Return

A standard rule of thumb: you need to receive a net 2% return after inflation and taxes. That means 2% ABOVE your break-even rate of return.

If you think the above break-dance move looks painful or impossible… think about the fiscal moves you’ll be forced to make when you’re old and gray if you don’t start saving and investing NOW.

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This entry was posted on Monday, July 7th, 2008 at 9:57 am and is filed under 401k / IRA, retirement, series. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.