3 Tips to Saving for Retirement.
I know most of my audience is in their 20s to 30s, and I know that retirement planning is not a major priority. While it may seem like an eternity away, the reality is these are the years to prepare. So I’ve compiled 3 simple tips that can help prepare for those golden years no matter what stage you are at.
Tip Number 1: Pay yourself First
Just by simply paying yourself first you can build a sizable nest egg for retirement. This strategy is where you save a portion of your income before you spend any money on expenses. When you save what is left over you run the risk of overspending and having no money to save. A great way to pay yourself first is your employer's 401(k) plan. This is an easy way to save because the money is taken out before you ever receive your paycheck. Remember to utilize their match, it is free money!
If you don’t have a 401(k) you can still use an IRA. It can either be a traditional or Roth account and the only difference is taxes. If you would like your money to grow tax-free and the ability to write off the contributions the traditional IRA is for you. On the other hand, if you want withdrawals to be tax-free then the Roth IRA is the right choice. There are pros and cons to each and if you have questions on which is right for you it’s best to meet with a financial professional.
Tip Number 2: Calculate How Much You Need
This number is the amount of money you need to fund your life when you are no longer working. According to the Department of Labor, only 40% of Americans know how much they need in retirement. This is a crucial number to know whether you are trying to retire early or at a more traditional age.
One of the more common ways to approach this calculation is using what is called the 4% rule. This rule says that over 30 years you can safely withdraw 4% of the money you saved without running out.
You can do your calculations quickly to find out how much money you will need. To calculate that number, you need to estimate your yearly expenses and then subtract any income you will receive, aside from your investments. Income includes social security, rental income, pensions, etc. Then you take the remaining amount and multiply it by 25.
So for example, someone who needs to live off of $50,000 a year and expects to receive $20,000 in social security benefits should take $30,000 and multiply it by 25. This means that person will need to save $750,000.
By establishing a base of guaranteed income, complementing it with a set-aside amount of protected principal and liquid conservative investments, and protecting it through a package of insurance products, you can potentially increase your withdrawal amount by as much as 30-50% more than the 4% before.
Tip Number 3: The Earlier, the Better
The earlier you can start saving for retirement through investing the better. This is because time is one of the best advantages to investing. Someone can invest less if they start earlier than someone who starts 10 years later due to the power of compound interest.
The image below is from an article by Business Insider. It illustrates 3 different investors saving at different times. The Purple and Red lines both save $300 a month but start 10 years apart and the Blue line saves $600 a month but at age 40.
*This is assuming a 5% annual rate of return.
As you can see the power of compound interest allows the individual that started investing at age 25 to achieve the highest savings at retirement age. In addition, the person at age 25 invested a lesser total than the individual at age 40. So, take advantage of your company 401(k) plan as early as possible. If that isn’t available to you there are other options such as an IRA.
Ultimately
These tips are meant to get everyone thinking about retirement and building some sort of plan. In a recent survey, they found 33% of Americans have saved nothing for retirement, and procrastinating is at the root of the problem. If you have any questions on these principles feel free to reach out.