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Retirement Planning Tips

One sure way to avoid being "poor" in retirement is to save lots of money during your working years. Short of inheriting a bundle or winning the lottery it's up to you to accumulate a pile of money for the future. Here are two often overlooked but important tips to consider while planning your retirement savings program.

Compute Net Worth With and Without Your Primary Residence.

Most people who own a house include its value in their total net worth. This is appropriate for estate planning, but it tends to lull people into a false sense of financial well being for retirement planning. After all, you need to live someplace so if you sell your house, you would need to buy another residence or rent. To have money left over after selling one residence and purchasing another, you would need to buy down or move to a cheaper real estate market. In either case, the bulk of the current value of the house may not be available for you to spend in the future. If you rent, you'll need a pool of money to pay future rents, which will increase.

Don't let the current value of your house make you think that your financially well off or "rich".

To avoid this trap, compute your net worth excluding the value of your primary residence. This figure, which is not distorted to the upside, is a truer measure of the actual amount of the money you'll have for retirement.

Compute Savings Requirements Using a Conservation Rate of Return

Many people don't save enough money for retirement because they assume a rate of return for their investments that is too high. Here's how this pitfall works. Suppose that you want to accumulate $500,000 over the next 30 years. If you assume a rate of return of four percent per year, you would need to save $720.41 each month. But if you assume a rate of return of eight percent, you would need to save only $335.49 each month. It easy to see, that rate of return determines how much you need to save. The rosier the rate of return assumption, the less you need to save and vice versa. But if your actual rate of return turns out to be lower than the assumed rate of return, you probably won't have saved enough to make your target nest egg.

It's easy to fall into this trap, particularly during bullish stock markets when double-digit returns appear to be the rule. With rising stock prices, you assume that high rates of returns will go on forever, so you limit your periodic retirement contributions accordingly. Then, when the market stops delivering the relatively high returns, you discover that your their retirement account has been underfunded.

To avoid this problem, assume a conservative long-term rate of return of three to five percent and beef up your monthly contributions. Making larger monthly contributions should ensure adequate long term financial security. And if your actual rate of return does better than expected, you'll have a even larger nest egg.

See the Target Nest Egg Calculator to study the effect of different rates of returns on future nest egg amounts.

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