How to Know If You’re Underfunded in Your Retirement Account

Reports of American workers being short on their retirement funds are rampant. The National Institute on Retirement Security frames the “underfunded” issue in real dollar terms, noting that retirement savings are “dangerously low”, and the U.S. retirement savings deficit is between $6.8 and $14 trillion.

Yes, too many Americans are underfunded in the retirement accounts — but how do you know exactly how much you’re underfunded? And better yet, what are the best ways to catch up?

First, there are some hard and fast formulas for really knowing if you’re underfunded for retirement — and by how much.

According to a recent study from MassMutual, the underfunding benchmark is this — if you’re able to replace 75 percent of your pre-retirement income at age 67 or whenever you first qualify for full Social Security benefits, then you are adequately funded for your post-career years. Anything less, and you’re missing the mark in financing a decent retirement.

But there are other ways to know if you’re underfunded in retirement, financial experts say.

[See: 10 Long-Term Investing Strategies That Work.]

“You can get your Social Security benefit estimate from, although you’ll notice that this is probably not enough to sustain your life,” says Dennis McNamara, a financial planner at Lighthouse Financial Advisors in Red Bank, New Jersey. “Know the delta — (the difference) between the Social Security amount you will receive and your monthly expenses.”

“Remember, this is the number you have to solve for,” he adds. “Tax laws change regularly, and the financial markets can throw curveballs — so you’ll never know exactly how much you are underfunded.”

Another way to estimate any retirement cash shortage is to know how much you are going to be spending in retirement. “What you spend now is the best guide available,” says Norman M. Boone, founder and president of Mosaic Financial Partners in San Francisco. “Figure that number out and adjust it by expenses that will go away after retirement (such supporting the kids, Social Security taxes, disability insurance and your retirement contributions). That’s your retirement spending estimate.”

Then get clear about what your other sources of income are likely to be, like Social Security, a pension, an annuity, rent from an apartment building or other sources of income, Boone says. “Identify the total amount and subtract those known income items from the expense total, and the result is the amount you will need to get from your portfolio.”

While there’s plenty of debate about the exact percentage of career-years income you’ll need in retirement, it’s reasonable to plan to pull out 4 percent per year from your portfolio, if you want your money to last for 30 or more years, Boone says. So, if the amount you need from your portfolio (from the above calculation is $40,000, then you’ll need a portfolio of $1 million, since 4 percent of $1 million = $40,000. Then, you can adjust that initial amount by the inflation rate each…

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