The best advice is to start now, because time is the most important factor in preparing for retirement.
Saving for retirement is a daunting task. It requires cutting back current spending in order to fund an unknown future. We don’t know how long we will live. We don’t know what our future expenses will be. Finally, we don’t know how much our savings will grow.
Nonetheless, despite these uncertainties, it is possible to start working toward achieving a successful retirement by taking a handful of steps in the right direction.
The power of compound interest is a powerful tool to leverage retirement savings. By starting early, not only do you reap the benefit of extra years of savings, but your savings will experience extra years of growth. This power of compound interest is demonstrated through a simple hypothetical example:
Starting at age 25, saving $100 per month at a 6 percent annual rate of return will yield $199,149 after 40 years. Yet starting at age 45, saving $200 per month at 6 percent will yield only $92,408 by retirement.
The longer period of growth has more impact than the level of saving.
Don’t leave money on the table.
Some companies match their employees’ retirement plan deferrals. If your company offers a match, then contribute at least enough to fully take advantage of its contribution to your account. That’s free money you don’t want to give up.
Take advantage of tax deferral.
Contributions to traditional retirement plans are tax deferred. This means you do not pay taxes on your contribution until you remove the money in retirement. Consequently, a contribution to your retirement account will reduce your paycheck by less than the amount saved. For example:
If your marginal tax rate is 25 percent, then a contribution of $100 would decrease your paycheck by only $75.*
This is a great way to start deferring part of your paycheck without feeling the full pinch. Keep in mind, however, that there are times when it is better to save to a post-tax Roth IRA than to a pre-tax traditional retirement account.**
Make saving a habit.
Commit to savings early on and make it a steady part of your budget. This is commonly called “pay yourself first.” After setting aside your savings and covering your necessary expenses, the remaining portion of your paycheck can be spent on discretionary expenses without guilt.
Save the raise.
Even if your savings start small, increase it with each raise. If you split each raise between savings and spending, then your savings rate can rise over time without having to cut back expenses.
Work toward 10 percent to 15 percent.
The actual savings you need for a successful retirement will depend upon many factors, including how long you intend to work, life expectancy, investment returns and spending levels in retirement. However, a good rule of thumb is to save 10 percent to 15 percent of gross salary. This level is appropriate for individuals who start saving early. With a later retirement savings starting date, the savings rate will have to be higher. This savings rate also only refers to money specifically saved for retirement. Additional savings for making a home purchase or to fund an education would have to be in addition to the rates suggested above.
Check the guidelines.
In order to determine whether you are on track, it is possible to check your current capital, debt and savings ratio against standard benchmarks. Different sources that provide financial benchmarks include Charles Farrell’s “Your Money Ratio$” with his ratios calculator, or Financial Finesse’s retirement saving benchmarks. It should be noted that these benchmarks have underlying assumptions of when you will retire and that your retirement spending will be a given percentage of your current salary (70 percent for Farrell or 75 percent to 80 percent for Financial Finesse). If you plan a different retirement age or to spend a different amount in retirement, then your benchmark will adjust accordingly.***
Time your mortgage payoff.
One great planning technique is to time your mortgage so that it is paid off at the same time you retire. This allows your expenses to drop at retirement and reduces the required portfolio to maintain your lifestyle. Keep in mind, however, that paying off your mortgage should not be done instead of contributing to your retirement account — your house can be a significant portion of your portfolio, but unless you plan to take out a reverse mortgage, it is not a source of income.
Preparing for retirement can feel like an overwhelming task. It is easily put off because the need seems so far away. However, the best advice is to start now because time is the most important factor in preparing for retirement. It may start out small, but with perseverance, those initial steps can lead to a comfortable cushion for retirement.
* This example is for illustrative purposes only – nothing is guaranteed.
** Always check with your tax advisor for advice.
***We have not vetted these sites for completeness or accuracy. They are for education purposes only. Always check with your advisors for advice.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing.