Most people have the idea that as soon as you leave school and start working, you should save for retirement. You keep saving until it’s time to retire, at which point you (hopefully) have enough money stashed away to start your permanent vacation.
That’s an overly simplistic view, however, that fails to take into account key steps you should take based on your age and how many years you are from your desired retirement date. The better approach is to consider retirement planning in phases of life, each with its own unique best practices.
20s to 30s: Early-phase retirement planning
The most important thing to remember as you begin your career and start saving for retirement is, most people are not saving nearly enough in their early working years. Above all, you do not want to be one of those people! These early savings years are in many ways the most important ones.
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The power of compounding interest cannot be understated. Putting $100 into a retirement account every month starting at age 20 is more effective than putting $100,000 into a retirement account at age 65. Even assuming a relatively low 5% rate of return, that $100 per month for 45 years will cost you $54,000, but thanks to compounding interest, it could be worth more than $200,000 when you turn 65.
Furthermore, you should increase your contributions as your income increases. Anytime you get a raise, a promotion or a new job with a higher salary, you should increase the amount you’re contributing to your retirement accounts. This will help you grow your retirement savings even faster.
If your employer offers matching contributions to your 401(k), take advantage of them. Always contribute at least enough to get the company match; to do otherwise is to turn down what is literally free money.
Don’t forget to consider taxation in retirement. Remember that you will pay income and capital gains taxes on money you withdraw from your 401(k) and IRA in retirement. That should give you pause when being told of the advantages of not having to pay taxes on that money now. After all, it’s unlikely the tax environment you’ll face in retirement will be as favorable as the one we have now.
Early career is when workers often find themselves in a considerably lower tax bracket than much later in their working lives. It’s likely you will make considerably more in the middle and late stages of your career than you will in your first, entry-level position.
In other words, it might be wise to consider contributing to a Roth retirement account. You’ll have to pay taxes on contributions now, but any increase in value that account experiences will not be subject to capital gains tax, and withdrawals in retirement won’t be subject to income tax. It may be considerably more tax-efficient to contribute to a Roth now than to convert your traditional retirement account to a Roth later in your career.
40s to 50s: The middle years
As you move through middle age, some significant life changes begin to happen. If you have children, they’ll likely move out during these years. By the end of your 50s, helping them pay for college will, hopefully, be an expense you’ll no longer have. In addition, you’re likely to be compensated much higher than you were earlier in your career. In short, you’ll have more disposable income: Make sure at least some of it is enriching your retirement accounts.
Once you enter your 50s, you have the chance to make catch-up contributions to your retirement accounts. This is a great opportunity to make up for any lax habits you had in your younger years.
This is also a good time to consider dialing back the risk in your retirement portfolios. The closer you are to your desired retirement date, the harder it will be to recover from market downturns.
In the 2008 downturn, many who were very close to or in retirement discovered they were in trouble, as they’d been invested under the assumption that returns on market investments would always be healthy. Once those returns fell off, so did the retirement savings of many people. Don’t follow their example: Especially later on in your investing journey, it’s not always necessary to hit home runs. Some singles and doubles along the way are perfectly fine. Make sure your risk is appropriate to your retirement savings phase.
60s: The end of accumulation
By the time you reach your mid-60s, you’ll need to decide what kind of lifestyle you want to maintain in retirement. Will you be happy sitting on the porch reading books, or do you want to travel and enjoy other expensive experiences?
If you hope to maintain a similar lifestyle in retirement to the one you have now, while you’re still working, it’s a good idea to have at least 10 times your annual salary saved. Social Security will not, and is not meant to, fund your whole retirement. It’s meant to be supplemented by your own savings.
Your sixth decade is a good time to seriously consider dialing back the risk in your retirement portfolio. If the market should fall, and much of your retirement savings is invested in stocks, you will have little to no time to recover your losses before you need to start drawing money from your accounts. This could result in a much leaner retirement, or worse, force you to exit retirement and get a job to make ends meet.
Your 60s is also a time of decision-making. You need to choose your Social Security strategy: Do you begin taking reduced payments early, or do you delay beyond full retirement age in order to receive larger checks? Do you start taking checks at the same time as your spouse, or should one of you delay?
Medicare is another important step in your 60s: You need to sign up for Medicare by age 65 or when you retire, whichever comes last. Failure to enroll on time can cost you a great deal of money throughout your retirement.
Finally, carefully consider whether you obtain or continue life insurance coverage. Life insurance can be a powerful tool to ensure your spouse and children are taken care of should you pass away unexpectedly. However, term-life insurance may never pay your family anything if you should live past the end of the term, and whole-life insurance is expensive, especially if you sign up when you’re older.
These are all complicated decisions that you should consider not making alone. A financial adviser can help you navigate the phases of retirement savings and help you pick the most prudent path to maximize your chances of enjoying your golden years in financial comfort. Especially as you approach retirement age, it’s important to be guided by a professional who can help you work through options and decisions on your way to a dream retirement.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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