If you are concerned about your retirement savings strategy or have not started saving for the future yet, our guide can assist you in starting, no matter the stage of your life or the amount of money you have to invest.
If you are still not 100% organized when it comes to your retirement, we will guide you through all the available retirement options and give some advice on how to use them properly.
The earlier you start, the better
Once you start earning, it is best to get in the habit of saving money for retirement as early as you can. The earlier you start saving, the more the power of compounding will work in your favor and enable a financially secure retirement. Compound interest is the capacity of your assets to produce earnings due to being reinvested thus generating interest for you.
Here’s an example of how the power of compounding works when you start saving early:
Person A who starts saving at age 25 and puts away $100 per month will have more assets at age 65 than Person B who starts saving $125 per month at age 35.
Investing a small amount over a long period can have a snowballing effect on investment outcomes compared to investing large amounts over shorter periods.
Most of us should start saving early — ideally 15% of our income starting at age 25 if we intend to retire by age 62, and this approach is backed by the Center for Retirement Research at Boston College. Starting later may require you to save more money, reduce expenses, and work harder and/or longer.
How much money do people need to save to retire
Aiming to save early may be logical and financially sound, but you will not always have the motivation to do it. Still, as you notice an increase in your account balance, it will begin to feel great and it’ll be just one of those feel-good things you love doing.
While many experts will advise you to save at least 15% of your salary, the actual percentage will rely on factors that are unique to your situation. These may include how long you plan to work, the type of inheritance you might receive, familial responsibilities, and many other variables. Therefore, start small, even if it is only $25 for every paycheck. Strive to save a bit every year. Start doing it early and regularly enough to create a saving habit. You have to account for rising inflation and change in prices of regular commodities and lodging, etc.
Understanding the rule of 25
The basic idea behind the rule is that if you can save 25 times as much as you intend to spend during retirement every year, your savings can last for 30 years from the time you retire.
Use these steps to calculate the rule of 25:
Although this is not 100% optimal, and there are still other variables, the rule of 25 can offer you a general goal towards which you should be moving. Keep in mind that this rule doesn’t really work if you intend to retire earlier because the traditional retirement age is a part of this equation.
Retirement saving plans
Retirement account options can be very confusing due to all the acronyms and similar names. Still, understanding them is essential to a successful retirement. These retirement plans include 401(k)s, 403(b)s, 457(b)s, IRAs, Roth IRAs, Solo 401(k)s, and more.
The variety of choices when it comes to your retirement plan varies depending on where you work and how you work (contractor, freelancer, etc.).
401(k) plans offer tax advantages for retirement savings. A standard 401(k) plan allows employees to make pre-tax contributions, which grow tax-free until you start withdrawing from the account after you retire.
Distributions upon retirement result in taxable gains, while withdrawals made before age 59 ½ are taxed and penalized. Employees can contribute after-tax cash to a Roth 401(k).
One-participant 401(k) plans are often called Solo 401(k)s. The type of 401(k) plan is not new. It is just an adjustment to the traditional 401(k) plan to cater to self-employed business owners as well as their spouses. The regulations and restrictions that apply to the regular 401(k) plan also apply to this variation.
Public schools, charities, and churches use 403(b) plans. Funds can grow tax-free until retirement with pre-tax employee contributions. These contributions are not taxable income. Distributions made before 59 ½ years of age may attract higher taxes and penalties, while withdrawals are considered regular income at retirement.
With a Roth 403(b), you make after-tax contributions and tax-free withdrawals in retirement, much like a Roth 401(k).
Similar to 401(k), a 457(b) is a retirement plan that is only offered to employees from the state, local, and certain tax-exempt organizations.
An employee may contribute to the tax-advantaged plan with pre-tax earnings, resulting in no taxation on the income. The 457(b) permits tax-free growth of contributions up until retirement. But, when a retiree withdraws funds, they are subject to tax.
Meeting your employer’s match
Make sure you meet at least the minimum amount of contributions required to fully benefit from your employer's match if they offer to match your plan contributions.
An employer might, for instance, promise to match 50% of employee contributions up to 5% of your pay. In other words, if you make $75,000 a year and put $3,750 into your retirement account, your employer will contribute an additional $1,875. This is basically getting free money.
Naturally, employers offer this kind of arrangement but if it’s on the table don’t regard it as something optional — it’s an employment benefit that can really impact the quality of your retirement.
The US government developed the IRA as a retirement plan to support workers and their retirement savings. As of 2022, individuals may deposit up to $6,000 into an account, while employees over 50 may deposit up to $7,000.
Here are the descriptions of each and how they vary from one another.
Traditional IRAs are tax-advantaged savings plans. Anyone who receives income from employment is eligible to make pre-tax contributions; these contributions are not considered taxable income. They grow tax-free in the IRA until we start withdrawing them at retirement when they become taxable. Early withdrawals are usually subject to more taxes and fines.
A Roth IRA, a more recent variation of a traditional IRA, provides significant tax advantages. Roth IRA contributions come from after-tax funds. The funds deposited into the account are already taxed. In return, you don’t pay taxes on any contributions or earnings withdrawn from the account at retirement.
Small business owners and their employees are eligible for the SEP IRA. The only contributor is the employer, and contributions are made directly into each employee's SEP IRA. Those who are self-employed can also open a SEP IRA.
In 2022, the contribution cap is 25% of earnings or $61,000, whichever is less. Determining contribution caps for self-employed people can be tricky to figure out so you might want to consult a financial adviser for this one.
Other IRAs (Spousal, Rollover, & Simple IRAs)
Some of the other IRAs include Spousal, Rollover, and Simple IRAs.
The spousal IRA lets the spouse of a worker with earned income contribute to an IRA.
A rollover IRA transfers a retirement account, such as a 401(k) or IRA, to a new IRA account while still benefiting from the tax advantages of an IRA.
SIMPLE IRA plans enable small businesses to contribute to a retirement savings fund. Employers must provide matching or nonelective contributions in addition to any pay reductions employees choose to make.
Other retirement options
Some benefit plans don’t generate returns as generous as others. Therefore, fully understanding a plan before committing to it is crucial for success. Here are some more retirement options that are solutions to specific situations.
GIAs (Guaranteed Interest Accounts)
Employers typically do not provide GIAs, but people can purchase these annuities to fund their pensions. To receive a monthly payout for the rest of your life, you can swap a sizable lump sum when you retire and purchase an immediate annuity.
Pensions are an easily defined benefit (DB) plan to manage since you do not need to do much as an employee. Employers fully fund pensions, which provide employees with a set monthly income when they retire. Based on this, because fewer employers are offering them, DB plans are now classified as a relic from the past.
Federal thrift plan
Members of the uniformed services and government employees have access to the Thrift Savings Plan (TSP). Their five low-cost investing alternatives include:
Moreover, federal employees can choose from a variety of lifecycle funds.
Catch-up contributions for those over 50
Because annual contributions to IRAs and 401(k) plans get capped, it is critical to start saving as quickly as possible. People 50 years or older at the end of the calendar year are eligible to make catch-up contributions to IRAs and 401(k)s. Therefore, if you have not been able to save as much for retirement as you would have liked over the years, catch-up contributions can help. In 2022, you are allowed to contribute up to $6,500 in additional elective salary deferrals.
Delaying Social Security is an option
The earliest you can start getting reduced Social Security retirement benefits is at age 62. As you wait to receive Social Security benefits after reaching full retirement age, your payments will increase by a set amount. Based on this, after you turn 70, you will not get any further increases.
Delaying benefits until full retirement age will qualify you for delayed retirement credit. When you postpone retirement past the full retirement age, your benefits rise by up to 8% annually. Additionally, it may boost the future eligibility of your spouse for survivor benefits.
Control your spending and save more
Making your monthly retirement contributions automated will provide you the chance to ultimately expand your contingency fund without having to worry about it. Going for an investment plan is not a bad idea as it takes away much of the monthly stress you deal with when allocating assets.
You may save money by haggling for a lower vehicle insurance premium or packing your lunch to work rather than purchasing it. If you can budget and figure out where your money is going and where you can cut back, you will have more money to save or invest.
Set good and realistic goals as you progress in life and your career, and do your best to respect the path you have chosen.
A survey conducted by the Employee Benefit Research Institute in 2020 found that only two-thirds of existing employees understand their retirement benefits. Knowledge is power and understanding the choices at your disposal is crucial to making the right ones. Your retirement is no joke and while it may seem like a distant future when you are young, the only stress-free way to actually ensure an easy retirement is to start saving early and have a plan.