The Importance of Saving (Part II)

Click here for Part 1 of this piece.

NEW YORK ( TheStreet -- Continuing from Part I of my article on saving for retirement, now our individual has opened a Roth IRA account with $5,500 to get the ball rolling and just took the first step to securing her financial freedom. It should also be noted that the account can be opened with any amount between $0 and $5,500.

To contribute the maximum amount per year to the Roth IRA, our individual will need to save about 15.3% of her take-home pay through her 30s. While this might not seem like a "fun" way to "spend" your money, it will prove rewarding down the stretch. By the time our individual reaches 40, she'll already have $60,500 in contributions alone.

Just for fun, we can assume she allocated 70% of her portfolio to stocks and 30% to fixed-income. On average, we'll say the stocks returned 8% per year and the bonds returned 3%. While contributions have totaled more than $60,000, returns from our investment strategy have brought the total up to $90,246. Not too shabby.

While our investor continues to save 15% of her $43,200 take-home pay through her 40s, she now has over $115,500 in contributions alone. With the increase in age, our investor has shifted herasset allocation to 65% stocks and 35% bonds in an attempt to decrease risk. After contributions and returns, the total savings is now up to $255,811.

Now that our investor is in her 50s, things change slightly -- most notably, the annual contribution limit. When you hit 50, you can contribute $6,500 instead of the standard $5,500. This is known as a catch-up contribution. With our investor still saving 15% of their pay, she will contribute another $65,000 to her Roth IRA over the next decade, bringing the total amount of contributions to a robust $180,500.

Let's again assume in our example the investor shifts slightly away from stocks in favor of bonds. The asset allocation is now 60% stocks and 40% bonds. Assuming the 8% return rates from equities and 3% return from bonds, the total stock fund is worth just over half a million dollars, while his bond fund is now worth just north of $100,000.

Her total retirement savings now accounts for $601,701.

Here is the math:

Starting with $5,500 at age 30, our investor saved $60,500 over the next 10 years; 70% of these funds were invested in stocks, which totaled $68,546, assuming an 8% annual return. The other 30% of her contributions were in bonds, which at a 3% annual return created a total of $21,700. Total savings is now at $90,246.

With the current balance of about $90,000, another $55,000 is contributed over the next 10 years through our investor's 40s; 65% of these funds were invested in stocks. After an 8% annual return over the previous 20 years, the equity fund is now up to $203,918. The bond fund, now 35% of the savings, is up to $51,893.

Through her 50s our investor contributed $6,500 per year, bringing the contribution total to $180,500. While allocating 60% of the money to stocks, the returns pile up to a massive $501,261 and the bond fund now totals $101,440 and makes up 40% of the allocation.

So what about the money? Instead of moving the entire hunk of cash to a bank vault, we want to keep it invested. With a conservative allocation of 30% stocks and 70% bonds, we will have an annual return of 4.65%.

Also in the example, our investor was saving 15% of her take-home pay. In her 40s and 50s, only about 12% was required for the maximum Roth contributions. The other 3% was saved in a similar, taxable brokerage account. During those 20 years, we remained in a riskier, 70% stocks, 30% bonds allocation and now have an account total of $60,164, pretax.

Now that our investor has hit 60, we're going to scale the taxable sum of $60,164 to a 50/50 stocks and bonds asset allocation. We will also apply the 15% long-term capital gains tax on monthly withdrawals because our investor has held these investments for one year or longer.

I figured that $3,500 per month was a reasonable amount of money for a single individual. Remember, a withdrawal from a Roth IRA has no taxes at this age, and represents most of the monthly sum (more below). Since she was able to responsibly begin saving for retirement at age 30, I will also assume our investor has paid off all major expenses, such as her mortgage.

If $3,500 after taxes is enough for our individual, I will look to withdraw approximately $3,200 per month from our retirement account of $601,701. While earning 4.65% annually, she will be able to make 337 monthly withdrawals, equivalent to just over 28 years. The other $300 per month can be taken from her individual brokerage account.

Our investor's brokerage account will be earning 5.5% annually, which is split evenly between stocks and bonds. No matter how you split the $3,500 per month, the average will run pretty evenly to our investor having enough money to make it until about 90-years-old.

Depending on whether you view the glass as half-full or half-empty, that's either great that your money will last that long or horrible that it will run out at that age. But, and this is a big but, keep in mind that we have accounted for zero Social Security and higher tax rates, (about 12% higher than the current rate).

We also considered a single adult. A married couple would, theoretically, be able to pay off expenses twice as fast -- although the expenses could also be twice as much as well -- and save twice the amount an individual could. Of course, that's assuming they make about the same amount of income.

While your money trail might not make it past 90, you might not either. With any luck, our investor will stay in the 25% tax bracket (instead of the 28% like in our example), and receive Social Security. That way her nest egg will last many decades and support a more luxurious lifestyle after all those working years.

To see how much you'll have after retirement, try this helpful calculator.

Also, check out MainStreet's IRA page for more tips and ideas on saving.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Bret Kenwell currently writes, blogs and also contributes to Robert Weinstein's Weekly Options Newsletter. Focuses on short-to-intermediate-term trading opportunities that can be exposed via options. He prefers to use debit trades on momentum setups and credit trades on support/resistance setups. He also focuses on building long-term wealth by searching for consistent, quality dividend paying companies and long-term growth companies. He considers himself the surfer, not the wave, in relation to the market and himself. He has no allegiance to either the bull side or the bear side.

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