How much money will be needed to save for retirement, and where will one get it? Believe it or not, most people will need an investment fund of $1 million or more to enjoy the kind of retirement desired - that is after taking into account Social Security and any employer pension plan.

To see how much is needed, first estimate how much money will be spent annually in retirement. One common way to estimate this is to assume that in retirement a person will spend a percentage of a pre-retirement income, say 64%. One study by professors at Georgia State University and by the Alexander & Alexander Consulting Group came up with the following estimates:

$20,000 76%

$30,000 72%

$40,000 71%

$50,000 74%

$70,000 77%

$80,000 84%

The percentages vary according to income level. Presumably this is because at higher income levels, the standard of living has more fixed expenses. But if you are not the average retiree, make more specific calculations by preparing an estimated budget of a planned retirement spending, and then adjusting for inflation.

Suppose an income is $50,000 today and a worker plans to retire in 10 years. At an inflation rate of 3%, his/her $50,000 today would be over $67,000 in 10 years. That means the spending needs in the first year of retirement will be about $50,000 (75%).

On average, about one-third of this will come from Social Security. The other $33,000 or so must come from your savings.

If the savings earn a conservative 5%, an investment of $660,000 will be needed to meet needs without dipping into principal. But there’s more. Everyone needs inflation protection. So, if 5% is earned on, an investment will be needed of more than $660,000, so that some of the income and gains each year can be invested. More risks must be taken and the return must be increased above 5% so that there will be an excess to invest.

A company defined benefit pension might provide some retirement income. But this is getting more rare every day. Most pension plans today are 401(k) plans - essentially are part of your investment portfolio. Even without a pension annuitization, it is unlikely to be indexed for inflation, so its purchasing value will diminish each year.

After figuring the annual retirement spending and estimating the total retirement fund needed, it is known how much is needed to save from now until retirement.

Many people look at the numbers and decide that reaching their retirement goals is impossible!

But it isn’t. Reduce current expenses and save more money. Use the tax code to help save and accumulate wealth faster. Here are the key ways to use the tax code to increase a retirement fund.

A retirement fund grows faster if a whole dollar is saved and invested instead of the sixty cents or less kept after payroll and income taxes. In addition, earnings on pre-tax investment dollars usually compound tax-deferred - helping the fund grow faster.

The first step, of course, is to enhance contributions to any 401(k) plans. Encourage your employer to help out by matching 401(k) contributions instead of giving pay raises or bonuses. For example, instead of giving a $1,000 raise, the employer could contribute a dollar to the 401(k) account for each dollar contributed, until the employer has contributed $1,000. This avoids income taxes, and the employer avoids payroll taxes. And this action has doubled the pre-tax dollars in a retirement fund.

There are fewer pension plans today because, of the limits Congress placed on them. But there are alternatives that give many of the old pension plan tax benefits.

• Non-qualified deferred compensation plan

This avoids all the pension plan restrictions. It is a private contract between the employee and the employer. Employees agree to work today in return for payment in the future. When the contract is structured properly, no taxes are owed until the money is paid. The future payment is what the worker would have been paid today plus interest. The catch is that people must take the risk of losing the money if the employer goes bankrupt and is liquidated.

• Charitable remainder trust

Set up and make contributions to a trust of which you can be the trustee. The contributions are partially deductible as charitable contributions, and the amount of the deduction depends on age. The trust can invest the contributions tax-free, so the principal grows faster.

At retirement, the trust begins paying the retiree (or retiree and spouse) an annuity for life. After death, the money remaining in the trust goes to a charity designated. The only limit on your annual contributions is that the charitable deduction cannot exceed 50% of adjusted gross income each year.

• Invest tax-deferred

If someone has to invest after-tax dollars, invest them so that income and gains compound tax-deferred. There are many ways to do this:

• Fully fund your IRA plan opportunities

Make the maximum $2,000 annual contribution even if it is not deductible. The compounding of gains within the IRA makes this worthwhile if the person will not withdraw the money for about seven years. If eligible, consider a Roth IRA instead.

• Invest in annuities

If the person is earning interest on bonds, savings accounts, or CDs and do not need the income for current spending, consider shifting that money to a fixed annuity. He or she will get a yield similar to that of an intermediate or long-term bond. The principal will not fluctuate with interest rates, and the interest will compound tax-deferred each year. The result is more money at retirement.

Distributions from a fixed annuity are taxed as ordinary income instead of capital gains. If capital gains taxes are cut, the value of fixed annuities is slightly reduced.

Tax-deferred compounding is supercharged if an IRA account is invested in small company stocks - those that historically have the highest long-term returns. This strategy should apply to all tax-deferred accounts.

When an employee has had a tax-deferred account and can choose how it is invested, go for growth. This magnifies the benefits of tax-deferral and increases the retirement fund far more rapidly. The "safe" investments of guaranteed investment contracts and other fixed rate investments are really very risky when compared to the wealth one could accumulate over time from small company stocks.

Small company stocks will fluctuate in the short-term. That should not matter if the participant is a long-term investor accumulating for retirement. But if it is bothersome, consider shifting the account among different investments periodically. Instead of sitting in a guaranteed return account, shift into the stock type investment that seems undervalued and due for a recovery. That should produce high, safe returns over time.

If participants save a little money each month and stick it in a savings account or cash equivalent, they are not likely to meet their retirement goals. But if they use the tax code to save more money and invest that money in tax-advantaged ways, their retirement should be what they’ve always wanted it to be.

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