When dreaming about a great retirement, many people think: will I have enough money to enjoy life? That’s why it’s essential to save for retirement. And yet, many do not have a single dollar in their retirement account.
Many of us don’t know where to start or how much money is enough. Research suggests that 61 percent of Americans do not know how much they will need to save for retirement. Also, 58 percent of baby boomers and 69 percent of millennials provided the same negative answer. These numbers show that something needs to change with your retirement planning. Fortunately, it is never too late to do something about it and start planning your future.
This guide brings you useful tips on how to plan for your retirement. We’ll also cover how to start saving for retirement and what your retirement goals should be, regardless of your age or financial status.
Saving for Retirement: Start Today
The most significant step in your retirement planning is to get started, and the best day to start saving for retirement is today. Think about your future and what you want to do in retirement and if you still have not made a retirement plan, create one today.
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What Are You Waiting For?
There are many reasons to create a savings plan as early as possible. For example, it is crucial to develop a habit of saving money. As we all know, it takes time to form a habit, so the earlier you start, the better. And do not worry; once you see that balance grow, it will only become more comfortable.
Another reason to start saving (and investing) before you retire is compound interest. For those who do not quite understand what it is, let’s explain it in plain English: a bank pays you interest for keeping your money there. The longer it keeps it, the more you earn in interest.
Compound interest is when you get paid interest on interest. In other words, your assets generate earnings, which are reinvested to make their profits. Sometimes, people refer to this “interest-on-interest” effect as the miracle of compound interest. So, all you have to do is sit back and watch your retirement account grow.
Determining How Much You Should Be Saving for Retirement
Retirement planning includes estimating expenses, identifying sources of income, setting up a savings plan, and managing assets. These points will help you determine an approximate figure of how much money you will need.
Step 1: Write Down Your Expenses
You can begin by writing down all your living expenses. Think about things on which you are currently spending money that you could cut when you retire. For example, if you commute to work now, you will have lower expenses for things like gasoline and car maintenance.
Step 2: Don’t Forget About Additional Costs
The next step is thinking about additional costs you may have in retirement. For example, you may want to travel more with your spouse or buy a property. Perhaps you plan to retire before you turn 65. That means that your employer will not cover your health insurance anymore and you have to pay for it yourself.
Thinking about these expenses can help you set your retirement goals and have a clear picture of your ideal retirement life. This habit is an excellent way of figuring out how much money you will need.
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Step 3: Get on a Path Toward Reaching Your Goals
Now that you set your retirement goals, you need to reach them. To reach your retirement goals, put your plan into motion. First, you need to evaluate your current financial situation. Take a closer look at your CDs (certificate of deposits), retirement account, savings account, and other assets. Do you need to boost your savings? And secondly, you can use the following three options to calculate your future retirement income:
The 80 Percent Rule
Your retirement income should be 80 percent of your final pre-retirement salary. For example, if your current income is $100,000 – 80 percent of that is $80,000. Make sure you adjust this figure up or down according to your plans. This figure is generally accurate for the average American.
The Four Percent Rule
To calculate the amount you will need to save to retire, split your desired annual retirement income by 4 percent.
The 15 Percent Rule
Invest 15 percent of your pre-tax income for retirement.
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Tips for Reducing Your Retirement Income Needs
There are many options to reduce your income need. One way is to eliminate debt before you retire. Most people try to pay off their mortgage before they hit retirement. Therefore, you can dramatically reduce your income need if you do not make a mortgage payment each month after retiring. Apart from your mortgage, you should do the same with your student loans, credit card debt, car payment, and other kinds of debt.
Another way is to live a simpler lifestyle than you do now. Maybe you should think about downsizing to a smaller house; you will automatically lower maintenance and utility costs. And, most retirees decide to use one car instead of two. All these moves could help you reduce the income you will need on which to live in retirement.
Saving for Retirement: Types of Retirement Plans
Choosing the type of retirement account for your retirement savings is essential. There are numerous options available for stashing your money, but most people are looking at two main options: IRAs and 401(k)s. In addition to these popular two, there are also:
- 403(b)
- 457(b)
- Solo 401(k)
- SEP IRA
- Simple IRA
- Roth IRA
- Health savings account
All these numbers and acronyms leave many people confused. However, you need to know that choosing a suitable plan depends on where you work. For example, young adults should consider starting by getting a 401(k) program through their employer. Most Americans work for companies that sponsor 401(k)s (79%). If you’re self-employed, you have more options, which might also require a combination of accounts. Your financial situation matters.
You should find a financial planner to go over your options. You have important decisions to make, including which account to choose, which a financial services company to choose, and how to make the best investing choices. If you cannot afford advisory services, check with the company that holds your money.
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401(k) Plans
A 401(k) plan is a workplace retirement account offered by your employer. However, note that many employers do not submit this savings plan. You can always sign up for this plan by filling out a form with a percentage of your pre-tax income you want to save. Then, your employer deposits that amount of money with a company that will hold it for you.
Employer Matching
Many employers will be willing to match employee contributions to a 401(k). The most common employer match is 50 cents for every dollar you save, up to a maximum employee contribution of 6 percent. An employer match is effectively free money, regardless of the offer. If you are not contributing up to the company match, you are disregarding one of the most important employee benefits. You can make your contributions through automatic deductions on your salary, which makes saving effortless and easy.
Taxes on 401(k) Plans
When it comes to taxes, you do not pay an income tax on the money you set aside in a 401(k). Those tax-deferred gains grow until you withdraw the money when you retire. You can remove it after you turn 59 ½ and perhaps consider using some of the money to buy long-term care. But, if you withdraw it before age 59 ½, you’re obligated to pay a 10 percent penalty on top of your regular income tax.
The downside of the 401(k) plan is that investment choices are limited. Also, there may be administrative fees charged by the company that manages the program.
Variations of 401k Plans
Variations of the 401(k) plan include:
403(b)
This plan is available to employees of some nonprofits, hospital organizations, and public education institutions. With this savings plan, you can invest in conservative or high-risk investments.
457(b)
Your employer offers this plan, which is available to state and local government employees. Contributions are taken from your pre-tax income, lowering your taxable salary. You can invest the contributions in mutual funds. Until you withdraw your retirement fund, earnings and interest are not taxed.
Individual Retirement Accounts (IRAs)
An IRA is a tax-favored investment account designed for building retirement savings. Two of the most popular accounts nowadays are the traditional IRA and the Roth IRA, but there are also SEP IRAs, SIMPLE IRAs, and more. All these accounts will award you for saving by offering tax benefits. With an IRA, you can invest in stocks, bonds, mutual funds, ETFs, and other types of investments. Buying and selling investments within the IRA is available. You can choose to invest your money, or you can hire a financial planner to do so for you.
An IRA is a reasonable consideration if you have maxed out your 401(k) contributions for the year or if your employer does not offer any retirement plan. However, note that you will have to pay federal, state, and income taxes, as well as a 10-percent penalty fee if you withdraw money before you reach the age at 59½.
Types of IRAs
Roth IRA
Unlike with a traditional IRA, with Roth, you will pay taxes on the money before you deposit it. Any money generated within the Roth is never taxed again as long as you comply with the withdrawal rules. Putting money in a Roth IRA is a great place to invest extra cash for younger people with a lower income or an entry-level salary. Those who are just starting do not pay a lot of income taxes now. When it comes to contributions, you can even contribute to both an IRA and a Roth IRA without exceeding the $6,000 contribution limit for the year.
SIMPLE IRA
The Savings Incentive Match for Employees or SIMPLE IRA is a retirement plan built for companies of the small range, generally with 100 or fewer employees. It works very much like a 401(k) but requires less paperwork. An employer is required to either match employee contributions or make unmatched contributions. The amount the employees contribute will reduce their taxable income for the year, and the money grows tax-deferred until retirement.
SEP IRA
SEP (simplified employee pension) accounts are a useful retirement savings option for self-employed people or small business owners. If you are an employer, you can contribute up to 25 percent of your income or $56,000 in 2019. You have a tax deduction on contributions with this account. Withdrawals in retirement impose a tax on funds at regular income tax rates.
Solo 401(k)
A one-participant 401(k) plan is sometimes called a Solo 401(k) plan. It is a traditional 401(k) plan covering a sole proprietor. A participant can make contributions as both the employee and employer (up to $56,000 in 2019).
Health Savings Account
People with a high-deductible health plan can save money exempt from tax in an HSA. You can contribute up to $3,500 a year or $1,000 more if you are 55 or older. When passing your 65th birthday, you can withdraw money without penalty, but you have to pay an income tax on that money. If you do it sooner for any reason other than paying for medical costs, you have to pay taxes and a 20 percent penalty.
Can You Have More Than One Retirement Plan?
Generally, it is best to keep all of your retirement money in one place. But, as you grow in your career, you may gather different retirement plans. When you start saving for retirement, a 401(k) is the first place to start. This workplace retirement account usually offers an employer match on your contributions. It is recommended to invest at least up to the match. On the other hand, a Roth IRA is also a great place to put away some extra cash for retirement. These two accounts can be a good combo.
Moreover, you can have both Traditional and Roth IRAs and can contribute to both in the same tax year. You can also have multiple IRAs, but the only requirement is that you do not put up more than the contribution limit across all IRA accounts throughout the year.
But, what about multiple 401(k) plans? Indeed, you can possess more than one 401(k) account.
Saving for Retirement: How to Invest Your Money
Saving for retirement is not enough; you need to invest in making that money grow. It is vital to keep it simple, and it is not necessary to be a financial expert to make investment decisions and start saving for retirement. Moreover, you should not even pay attention to the stock market. Your primary focus should be on making the contributions.
Grow Assets with a 401(k)
If you have a 401(k) plan, you can grow assets over a specified period thanks to target-date mutual funds. This fund is based upon the year you predict you will retire, and it adapts investments over time. After the initial launch, a target-date fund has a higher risk tolerance that tends to decline as their target date approaches.
If you are in your 20s or 30s, you can take more significant risks with your investment because you will not need to access your money for a long time. That means that you have time to let your investment grow. You can allocate your investments in international and domestic stocks.
Index Funds
Additionally, you should consider buying something called an index fund. It is a type of mutual fund constructed to match the components of a financial market index, such as the Standard & Poor’s 500 Index (S&P 500). Index funds charge lower fees than traditional mutual funds, which is a significant boost to your annual return and overall returns as well.
The question is: how do I choose index funds? Some people try to buy every American stock, gaining exposure to the entire stock market in the United States. Others try to buy every bond issued by a company in a particular country. Whatever option you choose, you will make the right decision since you will not sell and buy the funds intensively anyway.
Exchange-Traded Funds (ETFs)
And finally, be sure to consider exchange-traded funds (ETFs). These are index funds that are easier to trade. You can buy and sell these funds and track entire markets with one fund.
Hard Assets
Apart from investing in stocks, bonds, and cash, some people invest in real estate or hard assets. It is a great way to earn a passive income to buy a property and rent it out. Considering you have an emergency fund set aside just for your rentals, and you focus on local properties, you are good to go.
Before you start investing your money, do some research. To make smart decisions, you need to know about how investments work and which ones are best for you. Many 401(k) plans offer various types of advisory services regarding your retirement planning and investing, including access to a financial adviser. You can also employ a financial planner if you need a more personal approach or you have substantial assets.
Pro Tip: Don’t Sell Stocks When Stock Market Crashes
People sell stocks all the time. But the one time you should not sell is when the stock market crashes. Yes, it can be tempting to sell assets once that happens. However, it is a huge mistake that can lead to locking in your losses and destroying the value of your portfolio. Instead, consider using a bucket strategy for retirees and those approaching retirement.
Using Social Security Benefits
After hitting retirement, focus on additional savings for retirees such as Social Security. You can use Social Security benefits to your advantage and boost your retirement fund. You might be eligible for full benefits, but that depends on your birth year. For example, if you are born in 1960 or later, you can receive full retirement benefits at 67. If you are born between 1938 and 1959, you will receive full benefits between ages 65 and 67.
You can get some Social Security retirement benefits at age 62, but you have to wait until your full retirement age to receive full benefits. Take note: you should delay Social Security until age 70. You should do this because your monthly benefit increases for each year you wait. Delaying might result in an additional increase in income. So why not wait a few more years? Consider delaying Social Security to avoid saving too little, which is something most retirees regret.
Social Security is Not an Income Replacement
The fact is that Social Security benefits can boost your retirement fund. However, most people assume that Social Security will take care of all their retirement expenses. That’s false because it not supposed to be an income replacement, and it probably will not provide enough money (after taxes) for all the expenses you will face in retirement. Instead, it is a supplement to your income.
You might not want to rely on Social Security when planning your retirement due to future changes in the program and plans to cut benefits.
The Only Reason Not to Start Investing in Retirement Today
With so many reasons to start with retirement planning listed above, there can be one that might prevent you do so. If you are in debt, you do not have much leftover cash to invest for retirement. Most people have car loans, student loans, credit card debts, and more. Statistics say that Americans spend nearly 14 percent of their income on credit card debt. After learning this, no wonder people put retirement savings last on their priority list.
However, there is a way to solve that matter. You need to get out of debt as soon as possible. Do you know that every dollar that goes to a debt payment is a dollar you could have invested? The key to removing your debt and starting your retirement goals is to get on a budget. Most people who are already debt-free are on the budget, and that’s their secret.
Final Tips for Getting Started Now
Here are a few tips that will help you get started.
Tackle your everyday expenses.
Create a monthly budget and stick to it. A budget makes it easier to control your money and tells you where each dollar went every month.
Manage your income increase.
If your income increases, do not spend it to increase your lifestyle. Instead, stash that money in your nest egg.
Do not overspend.
Studies show that the average American spends almost $1,500 on non-essential items every month. These items can be magazine subscriptions, eating out, gym membership you barely use or impulse purchases. While it is fine to enjoy life, you do not want to let your recklessness harm your future. Cut down spending on non-essentials and add that amount to your retirement account.
Once you get out of debt, you will master budgeting and use your skills to focus on saving for retirement and investing.
Have you retired already? What is your advice on saving money for retirement? Please feel to comment in the section below.
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