How to Save for Retirement
September 9, 2020Retirement Wealth
Even if you do not have a huge amount of money, you should save for retirement. With the right strategy, an ordinary person can retire comfortably.
These days, Americans do not have nearly as much saved for retirement as earlier generations did at the same age. Most people do not even know how much money they will need to retire, and many Americans who work full time are not saving anything.
People retire comfortably by having a plan and a budget. Know as much about your options as possible and get a job with retirement benefits. Save extra money in addition to your employer's retirement benefits and start saving sooner rather than later.
Not having enough saved for retirement puts people at risk of poverty later in life or at least a much lower standard of living than they had when working.
Table of contents
What you want to do after you are retired
Do you want to be rich, or do you only want a comfortable existence? If you want to drive expensive sports cars or travel all over the world, you will need a lot of money. If you only want an ordinary life, you won't have to save nearly as much.
Before you start saving
If you have a choice between paying off some credit card debt and putting the money towards retirement, you are usually better off paying off your debts. While you should prioritize saving for retirement over many other things, don't prioritize it over paying off your debts.
The interest on your credit card debt is usually going to be more than the interest on your retirement savings. Pay off your credit card debt first and then use the money you save on monthly payments to increase your retirement savings.
If you owe money to more than one lender, pay off the high-interest debt first. Once you pay off the first half of your debt, it will become easier to pay off the other half.
One of the best ways to get out of credit card debt as quickly and painlessly as possible is to take out a low-interest loan to pay off all of your credit card debt right away. If you have a reasonably good income, you can realistically get a loan that has a lower interest rate than your credit cards do.
Your loan may be zero interest for some time, and you might be able to pay it off before your interest payments begin. If you can get a loan with no interest for a year or one and a half years, you can pay off a lot of debt with payments of $500 per month or less. Paying monthly fees on credit card debt can slow everything down when you are trying to save money.
Set up an emergency fund
While you should start saving for retirement sooner rather than later, you should prioritize being out of debt and having an emergency fund. If you have an emergency fund, you will not have to sell your investments if you are temporarily out of work.
An emergency fund should be enough to live on for two to six months. If you withdraw money from a high-interest retirement account while between jobs, you could miss out on decades worth of compound interest.
One thing at a time - set up an emergency fund that earns interest first, then create a retirement account. If you are in your twenties and not yet a homeowner, your emergency fund might only be enough to last for two months. If you are older and own a home, you should keep more like six months worth of expenses saved.
How to save for retirement
A comfortable retirement requires long term planning and financial discipline when you are younger. You might have to save as much as a tenth of what you earn.
This sounds like a lot, but after you get in the habit of saving that much money, you will no longer worry about it. You will plan your life around whatever your income is after your retirement savings.
Find a high paying job sooner rather than later
It is much easier for richer people to retire than for poorer people to retire. The first thing you need is a reasonably good income. It doesn't have to be a huge amount of money - ordinary people retire, but you won't be saving for retirement if you're broke. Do whatever it takes to succeed in your career.
Find a job with a pension plan
Learn about your company's pension plan in detail. How many years do you have to work for them to qualify, and what happens if you lose or give up your job before you retire? How much more will you have to save in addition to your pension plan if you want to retire with enough money?
Find a job with the best retirement benefits you can
The best way to retire well without being rich is to get a job with excellent retirement benefits while you are still relatively young. Your employer might be willing to match all of the money you deposit into your 401K account if you have been working for them for long enough.
For example, if you deposit $100 of each paycheck into your retirement account, your employer might add another $100 to it. With interest, this can add up to a fortune over many years. Many people can afford to retire primarily because of their 401K accounts.
Why does one need a retirement account instead of simply saving money?
401K accounts and other retirement accounts are tax-free or at least have tax benefits over saving money without an account. If you have a retirement account, you may be able to deposit pre-tax income into it.
If you do not have a retirement account, your income will be taxed before you have a chance to deposit it. Many employers offer many other benefits to those who use their retirement savings accounts.
What different types of retirement accounts are there?
Before you start saving for retirement, you should know all of your options. You could lose tens of thousands of dollars or even more money if you do not make the right decisions about where you put your money.
IRAs are retirement accounts that you open yourself. IRAs are never through employers.
One advantage of an IRA (individual retirement arrangement) is that money you put into your IRA is usually tax-deductible. There are also no taxes on interest gains with an IRA. Only if you withdraw money from your IRA do you have to pay taxes.
IRAs are an excellent choice for people who earn a lot of money, as you can set up a typical IRA no matter how much money you make. There is, however, a limit on how much money you can put into an IRA per year.
You can, unfortunately, only contribute $6000 before and $7000 after you turn 50. Depending on how much you make, how much your spouse makes, and what other retirement savings you have, your contributions might not be tax-deductible.
You can also withdraw money from an IRA before you retire, but there is a 10% tax if you are under the age of 59 1/2. Make sure you have some savings that are separate from your retirement savings so that you do not have to withdraw any money early.
Unlike with traditional IRAs, you cannot make contributions with pre-tax income. This significantly reduces how much you can save. However, Roth IRAs have the advantage of entirely tax-free withdrawals after you retire.
Money in a Roth IRA account will still grow tax-free. You can only contribute the same $6000 or $7000 per year to a Roth IRA as to a traditional IRA.
Another disadvantage of a Roth IRA is that it is not for very higher income earners. If you earn more than $122000 per year, or you and your spouse earn more than $193000, there are even more restrictions on how much you can contribute per year.
457 Plans are mostly for people who work for state governments. You can contribute to these plans with pre-tax income, which makes every dollar you earn worth more in the long run.
457 plans have a high yearly contribution limit ($19000), and if you started saving for retirement late, they might let you contribute even more than $19000 per year. 457 plans are excellent if you are working for the government and can get a 457 plan.
Defined benefit plans
These are better known as pension plans. Many companies still offer them even if 401Ks have largely replaced them. A company will use the employee's age, length of income, and pay to determine how much of a pension they will receive.
Many employees prefer these traditional pension plans because they know how much they will receive in retirement if they stay with their company until the end of their careers.
Actuaries and employers decide how much money goes into a pension plan each year. Some employees prefer this because they will not have to be responsible for contributing money to their retirement accounts themselves.
There is no contribution limit other than what employers and actuaries decide. Income put into a pension plan is pre-tax. However, you can be taxed on money from your pension after you retire.
401K plans are more popular than defined benefit plans these days. You can put pre-tax income into a 401K, but you may pay taxes on your withdrawals after retirement.
Depositing money into a 401K is automatic as it is taken out of your paycheck. The automatic deposits are clearly for the best, and they take the effort and decision making out of retirement planning.
Unlike IRAs, 401K plans are always through your employer. An advantage of 401K plans over IRAs is that the contribution limit is higher. You can deposit $19000 per year at any age and $25000 per year after turning 50.
Are riskier options such as stocks a good idea?
You can make or lose a fortune on the stock market or on any other kind of a risky way of making money. If you are going to put a lot of money into risky investments at any point, you should do this when you are young.
Losing most of your money on a risky investment in your fifties can make the rest of your life much worse. Losing money to a bad investment in your twenties is not as disastrous. A younger person still has time to make up for their losses.
When investing in stocks, pick a mix of high risk and relatively low-risk investments. In the long run, the stock market as a whole outperforms retirement savings plans. The stock market is a gamble, but it is a gamble in your favor.
Be realistic about how much of your children's education you can pay for
Everyone wants to be able to afford to help their children succeed, but you have to be realistic. Not everyone can afford to send more than one kid to an expensive school and have them graduate with no debt at all. Your children might have to go to relatively affordable schools - not everyone makes a fortune, and you should not destroy your retirement savings to give them an expensive education.
Your children can make it in this world without an enormously expensive education. Some schools are just too expensive for most middle-class people to afford. You might work a little longer so that your kids can graduate with less debt, but don't sacrifice too much.
You do not have to pay for the entirety of your children's education while they are in college. They can take out loans for some of it, and you can help them pay off the loans later.
You can save more on a budget than you think
Even if you don't make a lot of money, you can still save for retirement. If you start saving early, you don't have to put away a great deal every year to retire.
Automatic contributions can help you save money. It is easier to save money when you don't have to think about it.
If you talk to your bank, you can have them automatically put some of your pay into your retirement savings every time you get paid. You will adjust to living on what you make after putting money away for retirement and will not notice or have to think about saving money.
It is also easier to have a reasonable standard of living on a low income than people think. You can cut costs and still have a life.
Spend money, but don't waste money. People waste money all the time. They aren't even trying to avoid wasting money and aren't paying attention to where their money is going.
If you tend to spend money with debit cards and not with cash, you can find out exactly where your money goes each month. Ask your bank for a list of all the purchases you made during the last month. You can also find this information through your online banking account.
If you look through a month's worth of purchases, you will quickly notice where you can cut costs. Many people spend money on things that they could painlessly give up just because they do not pay attention to where their money is going.
If cutting small costs is not enough to save enough money, you might have to give up some more significant expenses even though this might involve sacrifices. You might travel within North America and not overseas.
You could also find a cheaper place to live. Rent should not take up too much of your income. If you live somewhere less expensive, you might suddenly find yourself able to save money.
Get a side hustle
If your work hours are fixed, you can still find a way to make extra money. A side hustle can add more than a little to your income, and often involves more exciting work than your day job offers.
Start saving sooner rather than later
If you spend half as long saving, you will have to save more than twice as much money each year to save for retirement adequately. A dollar saved in your twenties is worth a lot more than a dollar saved in your fifties because you gain interest in it for far longer.
Your income is also typically lower when you are younger. However, you might not want to postpone saving until your income is higher if you know what early saving is worth after many decades of interest. Your income may not be very high, but a young person also has fewer expenses and responsibilities.
You can get way ahead of most people and make life easier later on if you start saving a little right away. This is because of compound interest. Exponential growth on what you invest means investing a dollar earlier can be as good as investing more than two dollars later.
If you invest $2000 at 25, you will only earn $60 per year when you first invest it at 3% interest. However, after 40 years, your investment will be worth about $6524.08 - and it will have grown by about $190 during the 39th year. Instead of growing by only $60 per year, you will be earning $190 worth of interest annually by the time you are 65.
If you invest the $2000 at 50, on the other hand, it will only grow to $3115.93 by the time you are 65. You will only earn $90.75 worth of interest on your investment per year.
If you start at 25, your yearly increase will go up from only $60 to $190, more than triple the amount of interest you earned in your first year. If you start at 50, you will only be earning one and a half times as much interest by the time you are 65.
The size of the investment will also more than triple if you start at 25. So a dollar invested at 25 is worth a bit more than twice as much as a dollar invested at 50 years old.
These numbers assume that the interest rate is only 3% and that you are not adding to the initial investment each year. The numbers get much better if you assume a better compound interest rate and assume you are adding more to the investment each year.
If you start with only $4000, contribute only $50 per month, and have an interest rate of 6 percent, $2000 can become $113,428 over 40 years.
That is not nearly enough to retire on, but it shows you how much you can save if you start early. When you are young, save something - it doesn't have to be much, even if it is just a few thousand dollars followed by 50 dollars a month, it adds up to a small fortune after a few decades.
Most people, unfortunately, don't save anything for retirement in their twenties. By the time they are saving anything, it is too late to earn as much as they could have from compound interest.
However, many people do manage to retire comfortably by beginning to save later in life when their income is higher. If you are middle-aged and don't have much savings, don't feel discouraged. There is still time to save enough money to retire comfortably.
How much money should I have saved at each age?
It depends on what you intend your post-retirement standard of living to be, but experts have some general guidelines about how much you should save each decade. A general guideline is to have one year's income saved when you are thirty, three years worth at forty, and eight years worth at sixty. When you retire at 67, you should have ten times your yearly salary saved.
Arguably, ten times your salary is too little, and you should aim for twelve or more times. It depends on how long you live. You can live well on about 75% of your pre-retirement income.
Many people live for a decade or more longer than the average life expectancy in the United States. If you are in good health, you will live for more like another twenty than another ten years after you turn 67.
Don't be pessimistic about how long you will live. Save enough that you can afford to live well for many years after you stop working.
About THE AUTHOR
With multiple family members currently in senior living facilities, David is in the trenches every week, learning the ins and outs of nursing homes, assisted living, memory care, and general senior living.Read more about David Bolton
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We love planning for retirement. It's somewhat of a hobby, and we want to share what we've learned with you. Over the years we've found the best ways to live, how to travel, take on new hobbies and give back. Happiness in retirement is the main goal, and having the right information allows us (and you) to achieve that.
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