I'm a Retired Financial Adviser: If You Haven't Saved Enough for Retirement, These Are Your Options
It's never too late to save for retirement, and there are plenty of ways to build up your nest egg, depending on the level of risk you're comfortable with. Here's a basic guide.
If you look at your accumulated savings and find you won't have enough at retirement, what can you do?
Fortunately, there are several options — and you can mix and match them. As a financial adviser with more than 35 years of experience, I've found many simple ways you can build up your retirement funds.
Start saving today
If you aren't already saving for retirement, there is no time like the present to start. Tomorrow is not soon enough. Particularly if you have been putting things off, now is the time to act. Procrastinating will only make things harder, so start today.
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For example, if you set aside $1,000 today at an interest rate of 6% (not guaranteed), it will grow to $5,743 in 30 years. If you delay saving for five years, it will grow to only $4,292 in 25 years. Delay for 10 years, and your $1,000 will grow to just $3,208 in 20 years.
Now consider what you might have at retirement if you start saving every payday, whether it's weekly, biweekly or monthly.
As your income grows, you should raise your contributions as you earn more. At a 5% growth rate of earnings, your income in 10 years could be 60% higher than it is today. You should probably save 60% more than you did when you started.
401(k)s and IRAs
When your employer offers a 401(k) plan with matching contributions, you should take advantage of it. Matching contributions are like free money. Pretax contributions will only partially reduce your net spendable income.
Let's say you are in a 20% tax bracket. Setting aside $6,000 per year ($500 per month) would reduce your take-home pay by only $4,800.
Next, consider the employer match. If that is $1,500 per year, your account value (without market changes) would be $7,500, while your spendable income would be reduced by only $4,800.
If your employer doesn't offer a 401(k), you should consider setting up an IRA. Your contribution level may be lower than you are permitted in a 401(k), and you won't get the matchings funds, but there are still the tax benefits of a tax deduction on your contribution and tax deferral on the account growth.
If you want to have your retirement withdrawals tax free, you can consider a Roth IRA. While you won't get a tax deduction now, your future benefits will be paid to you without any income taxes. Roth accounts require that the account be in effect for at least five years and that you are over 59 ½ for tax-free withdrawals. Money that you deposited into the account, but not its growth, can be withdrawn tax free before 59 ½ since you've already paid the taxes on those funds.
Other advantages of a Roth account are that retirement withdrawals won't push up your tax bracket in retirement and they won't be counted when calculating your Medicare Part B and Part D premiums.
Risk and the power of compound interest
If you plan to work longer, your money will have more time to grow. The longer you work, the more money you can save and invest. When you finally retire, you'll probably have more money to spend. Take as much risk as you are comfortable with. Extremely safe investments, such as fixed-rate accounts, may not fluctuate, but they won't grow a lot either.
For example, at 2% compounded interest, your money will take 36 years to double. At 4% compound interest, your money will double in 18 years and quadruple in 36 years. At 6%, your money will double in 12 years and be worth eight times as much in 36 years.
Is it worth taking extra risk for more return? Only you can decide. Even if there are substantial fluctuations when you begin, 10, 20, 30 or more years can help make up for initial setbacks.
As time passes, you can always adjust the level of risk you are willing to take. In 10 years, you might allocate a quarter or a third more of your investments to assets with more or less potential growth and risk.
As advisers, we recommend allocating your assets among a variety of choices. Some are very safe, such as U.S. Treasury bills and insured savings. Others, such as longer-term government bonds and corporate bonds, offer potentially higher returns. And investments like stocks have even higher potential returns (but with more fluctuations).
Annuities
Once you have contributed to your 401(k) or IRA, you can also consider tax-deferred annuities. These are issued by insurance companies, and while they are a form of non-qualified (non-deductible) retirement plan, their earnings are tax-deferred.
Fixed-income annuities are similar to CDs or bonds, with rates set for a specific period. Of course, early withdrawals may be subject to penalties. Variable annuities offer a variety of separate accounts that are similar to mutual funds and offer returns that depend on their portfolios. In good markets they can rise, and in poor markets they can fall.
When you withdraw funds from an annuity, taxable gains are subject to ordinary income tax rates and don't receive capital gains treatment. You should also know that withdrawals before age 59 ½ may be subject to income tax penalties.
Life insurance
Cash value life insurance can also be used as a retirement vehicle. While the primary purpose of life insurance should be protection for your loved ones or your business partners, the cash value that grows over time can be used for other purposes. When you no longer need the death benefit, you can convert the contract to an annuity to provide income for a fixed period or for life.
ETFs and mutual funds
Other investment choices for retirement include exchange-traded funds (ETFs) and mutual funds. These diversified portfolios are subject to current taxation, but qualified dividends and capital gains receive favorable tax treatment.
Also, you can invest in portfolios that pay little or no dividends and or capital gains until you sell them. Only then will you have to pay taxes.
In short, start early, be patient, invest as much as you can and increase the amount you invest over time. Be willing to take some risks, and consider income taxes when making your choices. Over the long term, you are more likely to build more retirement assets.
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