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

Brian O'Connell

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 SSA.gov, 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 year."

"That way, you've figured out what your expenses are likely to be and covered them with all of your income sources so the amounts are equal," he notes.

Your age also factors into any reliable underfunded retirement calculation, says T.J. O'Meara, a financial planner with Moneta Group, a registered investment advisory firm based in St. Louis.

"For example, for younger folks, hard retirement projections are academic, O'Meara says. "It's kind of like Drake's equation; there are too many unpredictable variables for which a very small error in the input will cause a very large error in the output. So if you're under age 40, just put your head down and save, and don't worry about any long-range calculations."

[See: 10 Tips to Live Rich While Saving for Retirement.]

If you're in that younger age category, O'Meara advises saving 10 percent for the majority of the first 20 years of your working life. "If you do that, at the very least, you'll be ahead of most of your peers," he adds. "If you're not, consider yourself off track, and save more."

For those closer to retirement, the math becomes more reliable, O'Meara explains. For those folks, the steps to run a retirement sufficiency analysis are typically as follows:

1. Figure out what you need cash-wise in retirement.

2. Figure out what social security will cover in retirement.

3. Figure out what other income you expect in retirement

4. Estimate how long you'll live in retirement.

5. Use your best available resources to run some numbers on your savings to estimate how that amount of money will be drawn down in retirement.

To improve your chances of being "overfunded" in retirement, financial gurus advise spreading your money around in as many long-term savings vehicles as possible.

"The most successful retirees we see are the ones who have several sources of income at retirement including a pension, Social Security and employer-sponsored plan, like a 401(k) and/or IRA plan," says Maggie Johndrow, a financial advisor at Farmington River Financial Group in Farmington, Connecticut.

The reality is that most people entering the workforce today do not have the benefit of a pension plan and the long-term state of Social Security, Johndrow says. "We tell our clients that both corporate and government policies are out of your control, but how much you contribute to your individual retirement accounts is not, so it's important to properly plan for retirement," she says. "Many financial advisors -- my firm included -- run comprehensive financial plans that can show individuals the likelihood of a successful retirement based on your individualized goals and the probability of not outliving your money. Make sure you take advantage of them."

The best way to catch up in an underfunded retirement savings scenario is simple -- spend less and save more, says McNamara. "I hate this. Clients hate this. But clients often fall short due to already formed lifestyles and spending habits that need to be changed," he says.

McNamara is also a big fan of working longer to cover an underfunded retirement portfolio. "I'd rather see a client switch to a job they love and work longer, as opposed to buckling down in a job they detest and having an arbitrary end date," he says. "The best way to catch up is to continue working. Retirement often leads to idle activity and idle minds."

[Read: 5 Ways to Transition Your Portfolio for Retirement.]

"Often, we just need to redefine our definition of retirement and simply find creative ways to supplement our lives with lower paying, higher rewarding roles."

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