Whether you plan to retire early or at a traditional retirement age, it is crucial to have enough retirement income to support your lifestyle. There are different types of retirement income: social security, pensions, investment income, real estate income, and business income, to name a few. In this post I’ll focus on building and increasing your contributions in traditional retirement investment accounts to help you save for retirement.
Planning for retirement can be overwhelming. Here are 5 steps to help you start saving for retirement:
Step 1: Contribute to your Employers 401k (or 401k equivalent)
Most employers offer a 401k (or equivalent), and will often match your contributions to a certain percent (i.e. you contribute 10% and they match your first 5% – the match varies). Even if your employer only matches 3%, aim to contribute at least 15% of your income.
You’ll need to research what funds are available (do this online, read your employer’s brochure or talk to your Human Resources). You’ll need to select a fund that matches your financial goals and risk tolerance, but don’t over analyze this. Yes, your employer’s fund may charge a fee (perhaps 1.5%, which is high), or you might choose too conservative or aggressive a fund, but your employer match will more than make up for the fee. And, the biggest advantage when saving is time. Make your fund election and automate your contributions now. You can make changes (increase/decrease contributions and change funds and allocation) later, as you become more knowledgeable. Don’t let analysis-paralysis stop you!
Don’t think you have enough money to save for retirement? Read my post about using an expense avalanche to cut expenses and increase money for saving.
Step 2: Open an Individual Retirement Account (IRA)
In addition to contributing to your employer’s 401k, you can also open an IRA. There are two types of IRAs: Traditional and Roth. Traditional IRAs are funded by pre-tax earned income, where you will pay tax during retirement when you start withdrawing from your account. A Roth IRA is funded with after-tax dollars (pay tax now and withdraw tax=free later). There are rules and benefits to both, but opening one is the key.
Although you must be 59 ½ years old before you start withdrawing without penalty there are several exceptions to each. Here is a link to Nerd Wallet’s post about these exceptions for traditional IRAs. One of these exceptions include taking substantially equal payment (once you start taking these equal payments, you cannot stop). For a Roth IRA, you can withdraw your contributions (not interest earned on your contributions) tax and penalty-free at any time.
I’ll emphasize again: Don’t get stuck with analysis-paralysis. Choose one (or both), start your contributions, and save for retirement. Again, you can open a different IRA in the future, and increase/decrease your contributions over time depending on your means.
Step 3: Open a Savings Account
One of the keys to growing your retirement savings is not using your retirement savings before you retire. Sounds simple, but it can be difficult especially if you don’t have enough savings to help you through difficult financial times.
Even if you don’t have very much to contribute, every penny counts. Having an emergency savings account can allow you to continue to contribute toward your retirement even when you have to cover unexpected expenses. Eventually, you can also build a planned savings account to cover big purchases such as a house, car, vacation and more. Here is one of my posts that explains my view on the value of having a larger cash reserve.
Make sure you find a high-interest savings account. If you don’t think you have any extra money to save, try using Digit to start your savings. I managed to save over $800 the first month I used Digit.
Step 4: Automate your Savings and Pay Yourself First
Make saving a priority. Your 401k (or equivalent) should be automatically deducted from your paycheck. If your employer allows, you might also be able to have your other savings deducted and automatically deposited.
Alternatively, you can set up automatic transfers at the beginning of the month or as you get paid. The goal is to pay yourself first. If you wait until the end of the month, there is a greater chance you won’t have enough money left over. Make saving a priority to increase your success rate.
Step 5: Maximize your retirement contributions over time
Increase your retirement and savings contributions as often as you can until you are able to contribute the maximum. The maximum contributions for a 401k is $18,000 per year ($24,000 per year if you are 50 or older). And, the maximum contributions for IRAs is $5500 per year ($6500 if you are 50 or older).
Maxing out your retirement may be impossible when you first start. But, if you make maxing retirement contributions a goal, you can incrementally increase your retirement savings over time, i.e. increase 1% each month (or quarter or year). Additionally, you can put bonuses and pay increases to help increase your contributions. Paula Pant at affordanything.com has a great post about her 1% savings challenge, which provides some great ideas.
The Power of Time and Compounding Interest
Instead of considering your age, especially since there are many in the FIRE (Financially Independent Retire Early) movement, let’s look at the number years you have to save for retirement. Whether you want to retire at age 30, 50 or 65, the sooner you start to save for retirement, the easier it will be.
Below are some examples of the amount of money you need to save to achieve $1,000,000 in retirement savings (assuming a compounding interest rate of 7%). The difference in the amounts is astonishing.
Saving for 40 years
Save $400 per month for 40 years = approximately $1,056,000
Maximize your retirement contributions ($1958.33/month, $1500 in your 401k and $458.33 in your IRA) = more than $5.1 Million!
Saving for 30 years
Save $850 per month for 30 years = approximately $1,043,000
Maximize your retirement contributions = $2.4 Million
Saving for 20 years
You’ll almost need to max out your contributions to earn $1Million ($1950/month = approximately $1,021,000)
Saving for 10 years
To accumulate just over $1 Million in ten years, you’ll need to contribute $5750/month.
As you can see, time really matters. The earlier you start, the better. But, even if you have short time horizon, you can still save a significant amount if you make it a priority (and find the means).
Done is better than perfect
Retirement investment accounts are considered long-term investments and should be treated as such. Your greatest asset is TIME! As you can see in the examples, the more time you have to contribute, the less money you’ll need to save for retirement. You can change your contributions and allocations, but you CANNOT make up for lost time. Need an example? Here is a post about how my husband and I are currently allocating our savings to increase our net worth by $100,000 this year.
If you have credit card debt (or any type of high interest debt), you should prioritize that and pay it off as quickly as you can. However, I would recommend you also start to save for retirement and contribute to savings, simultaneously. Do the best you can and increase contributions over time.
Do you have more money to invest? You can open a non-retirement investment account (or pursue any other investment or business interests you have).
Make saving for retirement a priority. Contribute to multiple retirement and traditional savings accounts and work toward maximizing your contributions. Automate your savings to ensure you pay yourself first. And start contributing toward retirement as soon as possible. The more time you have to contribute, the less money you’ll need to build a sizeable retirement savings.
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