If monthly bills are the stick prodding you to work every day, then retirement is the carrot.
Sure, at times that sweet root vegetable feels so far away. Preparing for retirement can be overwhelming when you’re still trying to save up to buy a home or send your kids to college.
But with a little guidance and the right information, you’ll find yourself on the right track to enjoy all the fruits (and veggies) of your labor.
"Most people will tell you to make very big changes in your life to ultimately retire well, but I think it’s actually about these incremental, imperfect, but implementable changes you can make."
Brent Weiss, Facet Wealth
Types of retirement accounts
Before you can start saving for retirement, you’ll have to decide what type of account suits your investment needs. If you’re lucky enough to have access to a workplace account, that’s often a great place to start.
A traditional IRA is an investment account that offers big tax breaks, meaning you could be saving thousands of dollars for your retirement.
One of the most common employer-sponsored retirement plans is the 401(k). Here's how to manage yours.
At any age, opening a Roth IRA makes great financial sense.
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Maximizing your 401(k) contributions
If your employer offers a matching 401(k) retirement plan, you’ll almost certainly want to take advantage of this perk.
The most common employer match formula, according to the American Society of Pension Professionals & Actuaries, is 50 cents per dollar, up to 6% of your pay.
Every cent your work contributes to this account is as close as it gets to free money, so you’ll want to ensure you get as much of it as possible.
Plus, 401(k) plans are tax-deferred, just like traditional IRAs. A part of your paycheck goes directly into your account before income taxes are taken out, and that money grows tax-free until you withdraw it in retirement.
Here’s how to make sure you’re maximizing your 401(k) employer contributions:
- Find out how much your employer is willing to match. Set that amount as a basic investing goal to make sure you’re not missing out on any cash.
- Plan your contributions. Make sure you’re contributing the right amounts at the right times so every contribution you make is matched.
- Automate your contributions. Take the thinking out of the process and have your money automatically deducted from your paycheck.
- Adjust when necessary, but keep at it. The key to being successful with retirement savings is to stay consistent. Even if you’re not able to max out your contributions one year, put away as much as you can reasonably afford every month. This will ensure you don’t miss out completely on money that’s rightfully yours.
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How much money do you need to retire?
Sadly, there’s no magic number for retirement savings. Your individual situation — income, tax bracket, cash flow, dependents, desires, debt — determines what your retirement will cost.
You may have heard you should aim to have $1 million in savings and investments set aside. But that may be too little or even too much depending on your individual needs.
Many people who plan their own retirements don’t factor in their post-retirement tax situation. For example, if a person’s income drops from $80,000 to $50,000 once they retire, their tax bill will be suitably slashed.
And even though you can’t rely on Social Security alone, it can really help fill in the gaps.
So while we can’t give you a magic number, it’s not as hard as you might think to put yourself on the right path.
Brent Weiss, a certified financial planner and co-founder of Facet Wealth, says you don’t need to make large, sweeping changes to start effectively saving for retirement.
Weiss suggests taking a 1% approach: Begin by putting aside 1% of your income and slowly adding on another percentage point every six to 12 months. Before long, you’ll have a solid nest egg set aside.
Social Security benefits in retirement
Here's how much you must earn, and when you should start collecting, to receive the maximum Social Security benefit possible.
Taking Social Security before full retirement age means you can expect a reduction in your monthly benefits. But there are some solid reasons to start taking benefits as soon as you can.
Social Security offers benefits for widows and widowers known as survivors benefits. Survivors benefits can cover a widowed spouse and other family members.
Investing in retirement
A common rule of thumb for long-term investing, including for retirement, is known as the 60/40 rule.
The idea is that you put 60% of your investing dollars into stocks, so you’ll have enough growth potential to meet your goals. The other 40% goes into bonds, to provide a stable source of income to fall back on in case your stocks don’t perform.
But many financial advisers have been getting away from the 60/40 rule because bond yields today are minuscule compared to the interest rates of yesteryear.
And the problem with rules of thumb is they don’t adapt well to different investing needs. Those who have a longer time horizon (meaning more years until retirement) may want to consider a riskier mix with more stocks, while those with shorter time horizons might decide to take on less risk to preserve as much of their wealth as possible.
Of course, the right mix for you is best determined with some help from your financial adviser and should be updated when you pass a new life milestone, like accepting a big promotion, getting married or having children.
To understand why it’s important to diversify and adapt your investment strategy to your risk tolerance and time horizon, it’s helpful to have a visual of how different assets have performed over the last 35 years.
These calculations, courtesy of Brent Weiss and the Bloomberg Terminal, include “nominal” (not adjusted for inflation) and “real” (adjusted for inflation) returns on an initial $2,000 investment 35 years ago.
How different assets stack up over time
How long will my retirement savings last?
Once you’ve got your retirement accounts set up and a plan is starting to take shape, you may start to wonder how much you can spend on an annual basis.
One rule of thumb that has guided the financial industry for nearly 30 years is known as the 4% rule.
Rookie adviser Bill Bengen came up with the rule after studying several decades’ worth of statistics on stock and bond returns, asking himself whether retirement portfolios from that time period could theoretically last up to 50 years.
He found that the answer was generally yes, if retirees withdrew no more than 4% of their assets per year. And in any case, they could reasonably expect their funds to last 30 years.
The problem is you have to stick to that 4% every year, no matter what. And that makes the rule unrealistically rigid for many people. Even Bengen himself has been compelled to revisit it to update it.
That’s because his original research only included two asset classes: Treasury bonds and large-cap stocks. By taking into account a third class, small-cap stocks, he now believes that 4.5% would be a safe withdrawal. Maybe even 5%.
That being said, most hopeful retirees would be best served by consulting with their own financial adviser about the withdrawal strategy that best suits their financial situation.
Pros and cons of retiring early
Unsurprisingly, many financial advisers aren’t huge fans of the FIRE movement.
"I hate it. I hate it. I hate it. I hate it," Suze Orman said when asked about FIRE by podcaster Paula Pant. "You will get burned if you play with FIRE."
Generally, they’ll remind clients that you never know what life might throw at you. And leaving the workforce before or right in the middle of when you’d be earning the bulk of your wealth makes it hard to return later if you need to.
Nothing’s more stressful than running out of money early in retirement or watching a stock market crash sink your portfolio for years on end.
But that may not worry you. And there’s a chance the 9 to 5 life just doesn’t suit you.
After all, many people see their lifestyles improve dramatically after they leave the workforce. They end up forging better connections with loved ones and having more time to make healthy meals and be active.
Plus, the quest itself encourages a number of good habits, like saving and investing, budgeting and thinking about retirement well in advance.
Pros
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Learning to live below your means
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Thinking about retirement early
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Freedom to travel/explore your passions
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Taking on only the work you want to do
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Leaving the 9 to 5 behind
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Potentially improved well-being
Cons
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Sacrificing your peak earning years
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Possibly running out of money in old age
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Living on a strict budget before and after retirement
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Portfolio could be vulnerable to stock market volatility
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Can’t collect Social Security until age 62
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Having to find your own health insurance
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Losing a sense of purpose
Sigrid is a senior associate editor on the Moneywise team, where she has also worked as a reporter and staff writer.
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