When it comes to retirement, one of the most valuable questions you can ask yourself is, “how much is enough?” Unfortunately, it can be challenging to determine the right amount because there are many variables to consider.
In this article, we’re going to discuss the finer points of saving for retirement so that when it arrives, you can feel secure in the size of your nest egg. Ideally, you shouldn’t have to limit your lifestyle or cut down on expenses during your golden years. So, the more planning and preparation you can do now, the better off you’ll be later on.
The Basics of Retirement Saving
Putting money away might sound easy, but if you want to be sure that your nest egg is sufficient, you have to be strategic about how and where you save. In this section, we’ll be going over the various types of accounts you might want to have and how to maximize your retirement investments.
One of the best ways to save money for retirement is to have someone else put it there for you. Employer-sponsored accounts are beneficial because they offer a fast and easy way to save a portion of your earnings. A 401k is an example of this type of account.
To help make your money grow faster, some employers will match your contributions to a specific level. As an individual, you can contribute up to $19,500 (2020) of your salary to a 401k or 403b. If you’re over 50, the cap is $25,500 instead to help you “catch up” your retirement savings (this doesn’t include employer contributions).
No matter what, any money that your employer puts away for your retirement is good. Since it’s free cash, you should take advantage as much as possible. Regardless of any specific cap, you should aim to maximize any employer contributions every year.
Also, keep in mind that some businesses will require those funds to be vested. This usually means that you have to stay at the company for a specific period, such as five years. After that, the money is yours, free and clear.
Individual Retirement Accounts (IRAs)
While a 401k or other employer-sponsored account is a vital saving tool, it’s not the only option available. IRAs can come with some significant advantages that can help you build your nest egg faster. There are two types of IRAs, Traditional and Roth. Here is a quick breakdown of each one.
This type of account allows your money to grow tax-deferred. This term means you get to claim any contributions against your taxable earnings for that year. So, if your income was $40,000 and you put $5,000 into a traditional IRA, your adjusted gross income (AGI) would be listed as $35,000.
Tax deferment is an excellent saving tool as it can reduce your tax burden substantially. If your IRA contributions put you into a lower tax bracket, your savings can be increased even more.
The trade-off of these deferments is that you will have to pay taxes when you take the money out. However, if you wait until retirement (when your income is lower), you should be able to save on taxes in the long term.
The total amount an individual can contribute to an IRA is $6,000 annually for 2020. If you’re over 50, you can put away an extra $1,000 as a “catch-up” contribution. This total includes both traditional and Roth IRAs.
Instead of deferring your taxes now like a Traditional IRA, you will be paying them up front with any Roth contributions. However, the benefit here is that your money will grow tax-free. So, when you withdraw from a Roth IRA in retirement, you don’t have to pay taxes on it.
You can withdraw contributions from a Roth at any time without a penalty. However, if you want to take out investment earnings before you’re age 59 1/2, you will have to pay taxes on them, as well as a 10% penalty. This penalty can also kick in if you’ve had the account for less than five years.
There are also income restrictions on this type of IRA. In 2020, if you make more than $139,000, you can’t contribute any money to a Roth. If your income is between $124,000 and $139,000, your contribution limit will be reduced. Individuals making less than $124,000 can put away the full $6,000 ($7,000 for those over 50).
Married couples contributing to a Roth have higher income limits. Couples making $206,000 can’t contribute at all, while those making between $196,000 and $206,000 can put away limited amounts. Married couples filing jointly can contribute the full amount if they earn less than $196,000.
How Much Should I Save for Retirement?
Now that you know which accounts to have, how much should you be putting away each year? Most experts will recommend that you save roughly 15% of your annual income. If you’re making $50,000 per year, up to $7,500 should go into a retirement account. This total also includes any match contributions from your employer, so keep that in mind.
While the 15% rule is a good starting point, it might not fit with your retirement goals. The specific details of one’s retirement plan will differ from person to person, but here are some of the most common elements to consider.
How Many Years Left Until Retirement?
Ideally, you can start saving early in your career. A best-case scenario would be to keep a portion of all of your earnings, starting with your first paycheck. However, according to most data, the average American doesn’t begin saving until age 31. If you’re already in your 30s and don’t have a retirement account, now is the perfect time to open one.
The longer you have between now and when you stop working, the less you’ll have to save each year. However, even if you’re behind the curve, saving some money is better than nothing. While you might have to postpone retirement to a later age, that’s a better option than not being able to retire at all.
What Will Be Your Retirement Expenses?
Although you won’t be working full-time anymore, you’ll still have bills to pay. These monthly expenses can include:
- A mortgage loan or rent payments
- Car loan
- Utility bills
- Insurance policies
You can control some of these bills more than others. However, when planning for retirement, it’s best to assume that your monthly expenses will be similar to what you’re paying now. While you can take steps to tighten your budget, it’s better to prepare for a higher amount.
How Much Will You Receive From Social Security?
As long as you work and pay taxes, a portion of your earnings goes into the Social Security fund. When you retire, you’ll get a check from the government based on your work history. Many of the rules regarding Social Security recently changed, and they’re likely to change as you get closer to retirement. Here is a quick breakdown of how this program works and how much you can earn each month.
- Early Retirement - The soonest you can claim social security from the government is age 62. However, your monthly earnings will be lower than if you waited until you were older.
- Full Retirement Age - Although the government considers 65 to be the “official” retirement age, you can delay payments until you reach age 70. After that, your earnings won’t increase, so there is no reason to continue deferment.
- Working While Retired - If you claim social security and are employed, your SSI check can be reduced. The current maximum income you can claim before reaching “full retirement age” without reduction is $18,420. After that, you’ll lose one dollar for every two dollars you make over the total. If you’re at full retirement age, your maximum income for 2020 is $48,600.
- Social Security Credits - To qualify for an SSI check, you have to have earned a minimum of 40 work credits. The value of a single credit increases every year. For 2020, that amount is $1,410.
Consider the 80% Rule
This retirement strategy is based on the idea that you can likely live on 80% of your current salary. In most cases, your monthly expenses will be lowered for several reasons, including:
- You may have paid off your mortgage by the time you retire.
- You shouldn’t have to commute as much, so your travel costs will go down.
- You might downsize your living quarters, which will require fewer bills.
- You may be paying for dependents (i.e., kids) now, which you won’t in the future
So, if you’re currently earning $50,000 annually, you should plan to live off of $40,000 in retirement. Based on the average earnings from social security ($1,500 per month), that leaves a difference of $22,000 annually.
Fortunately, both the 80% and the 15% rules can work together in your favor. If you are maximizing your retirement contributions to cover 15% of your salary, that means you’re currently living off of the remaining 85% . So, reducing your expenses to match the 80% rule isn’t as drastic as it might seem initially.
Other Considerations for Retirement Saving
Having a total amount in mind is one thing - reaching that goal is another. Here are some other strategies and tips to consider to help you build a sufficient nest egg.
Create an Annual Savings Plan
Once you have a goal in mind, you can work backward to determine how much you should be saving yearly and monthly. What you need to remember with this plan is that your retirement accounts will accrue interest over time.
We highly recommend using a free retirement calculator to determine how much you should save to reach your nest egg. This way, you can figure out how well you’re doing right now and make adjustments as necessary.
Contribute to Savings First
One reason why it’s so hard for individuals to save is that they wait until the end of the month or the year to do it. Instead of waiting to see how much cash is left, you should first put money into a savings or retirement account.
For example, if you want to save 10% of your income, you put that away with every paycheck. While you might have to dip into your savings on occasion, keeping it out of sight will help you avoid temptation. Overall, it’s better to pretend that money never existed.
Talk With a Financial Advisor
Saving for retirement can be daunting, particularly if you’re behind schedule or worried that you’re off track. A financial advisor can help you assess your current situation and your future needs.
With these variables, you can develop a comprehensive plan to get you on the right path toward retirement. No matter where you are now, you can always improve your situation in the future.
Contact NextGen Wealth Today
Don’t let retirement planning overwhelm you. Instead, let us help by building a smart plan for your golden years. We have the tools to help you make the right financial decisions. Call us today to find out more.