Get A Mid-Life Retirement Checkup

If you're between ages 45 and 50, it's time for a mid-life retirement checkup. Back in 1999, you would have been 35 or 40 years old and probably predicted that your finances would look a lot different in 2010 than they do today. But with two massive bear markets under your belt, it's been tough to build assets for retirement.

Where Do You Stand. To get a sense of whether you're on track for retirement, there are some simple calculations you can run. The first is to run your ratio of financial assets to your household income. So basically add up all the money you have saved in your 401(k), IRAs, annuities, brokerage accounts or any other investment account and divide that number by your household income.

That will give you a number that I call your Capital to Income Ratio, which is the amount of investment capital you have to your current income. At age 45, you would like that ratio to be around 3.7.

• So if your income is $100,000, you would like to have $370,000 of investment capital ($370,000 / $100,000 = 3.7).
• If your income has been volatile over the last four or five years, then take an average of your household income over those years and use that figure to calculate your Capital to Income Ratio.

If you're 50, then you'd like your Capital to Income Ratio to be about 5.2.

If you're close to these numbers, then you're in good shape for retirement. If you keep saving around 15% of pay between now and age 65, you're likely to be in a position to retire on about 80% of your pre-retirement income once you factor in your Social Security. The basic goal is to get to about 12 times your pay in savings by 65, or a Capital to Income Ratio of 12.

But what if you aren't at these numbers? Where are you headed and what can you do?

Let's assume you're 45 and your Capital to Income Ratio is only 2, what does that mean? It means you're probably on track to retire on about 50% to 60% of your pay (again factoring in Social Security).

• If your 50 and your Capital to Income Ratio is only 3, then you're also probably on track to replace about 50% to 60% of your income in retirement.

But don't despair if you're middle aged and a bit behind. You've got between 15 and 20 years to repair things. That's actually a lot of time, and many good things can happen to significantly improve your financial situation. But you need to start now.

At a minimum, most people need to bump up their savings rate. If you increase your savings by 5% a year for the next 20 years, it can boost your income replacement rate in retirement by 8% to 10%. If you up your savings rate by 10%, that could increase your retirement lifestyle by close to 16% to 20%.

The second thing you need to do is make sure you get that mortgage paid off before you retire. If you're 50 years old with 20 years to go on your mortgage, you may want to consider paying on a 15 year schedule. That way you're making a little extra progress each year, and will be debt free by 65.

Take a look at your current mortgage and figure out when it will be paid off. If that's after the date you plan to retire, then call your mortgage lender and ask them how much extra you need to pay each month to be debt free by your retirement age. Then do it.

• While some people believe they can carry mortgage debt into retirement, if you get hit with a bear market and low interest rates during the first part of your retirement, you'll need to liquidate assets to pay the mortgage, which will substantially increase your odds of running out of money. Oh, and what are the odds of that? Well, for those who were unlucky enough to retire in 2000, they are living it.

The key to all of this is to start making consistent and meaningful changes today. Because of the power of compounding and the positive cash flow effects of debt reduction, increasing your savings rate and stepping-up your debt repayments today will significantly improve your finances 15 to 20 years down the road.

Think Long Term. Planning for retirement requires you to think long term, which many people don't do. They procrastinate and figure they'll deal with it later. Well, think again about where you were in 1999 and how fast those 10 years went by. Don't let another decade escape without making meaningful progress toward building financial independence.

Bottom line. Make an honest assessment of where you are today, and begin taking the simple and fundamental steps that can change your financial future.

More Ratios: Want to learn more about the ratios mentioned in this post and how to prepare for retirement? Investigate my new book, Your Money Ratios: 8 Simple Tools For Financial Security, which the Wall Street Journal called some of the "smartest tools we've seen" for planning your retirement.

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