The journey to retirement has seen significant changes in the last two decades. While the concept of saving for the future is the same, the next generation of retirees will experience it differently than their predecessors. People live longer, pensions are few and far between, and bond yields are lower. These conditions make an early start on saving and regular contributions critical. Here are some things savers can do now to secure a comfortable retreat from the workforce.
Estimate Your Monthly Expenses in Retirement
Imagine your lifestyle in retirement. This will help you shape your financial plan. In addition to essential expenses like housing, food, and healthcare, you should also consider the cost of travel, entertainment, hobbies, and activities in your annual budget. Evaluate current expenditures such as childcare or a mortgage that may not exist in retirement. Inflation should be a factor as well. The list below considers the main costs that affect retirees.
- Housing, utilities, maintenance
- Food, clothing, transportation
- Healthcare
- Travel, entertainment, hobbies, and activities
- Life insurance
With today’s cost of living, some experts estimate that people should save $2 million to retire, a considerable jump in the last several years. While there are other calculation methods, it’s best to consult a financial planner to determine your needs.[1]
Create a Budget
Saving for retirement means financially prioritizing it as you would food, housing, or utilities. Once you know what you need to retire, you can calculate what you should save monthly. You should feel secure in the amount you contribute. Ensure you have enough to cover your expenses and a reasonable spending allowance when determining your monthly retirement contribution. Cut back slightly on unnecessary spending like dining out or subscription services and redirect those funds toward your retirement account. Contributing to your retirement should not deprive you of what makes life enjoyable, but making informed and careful choices about how you allocate your funds will allow you to maintain your lifestyle into your golden years. Take advantage of automatic transfer tools that send money directly from your checking to your retirement account. This will allow you to stay regular in your contributions and prevent those funds from being spent in other ways.
Carry minimal debt
After all those years of saving money for retirement, you should not spend it paying down debts. Those hard-saved funds need to sustain you through your golden years. Strive for a strong credit score with regular mortgage, car, and utility payments and credit line purchases you can pay off monthly. A clean balance sheet will help you to reach 65 debt-free. Ideally, that includes student loans, car, mortgage costs, and any outstanding credit-card debt.
Select retirement account(s)
Without putting money toward retirement, there would be nothing to build upon. Saving is the top priority, but growth over time will allow you to reach your financial goal when you retire. Compounding occurs when gains yield additional gains. This means that growth on an investment will continue to build based on that growth rather than the original investment amount. Several retirement savings account options use the power of compounding. Here are a few to explore.
- Traditional IRA— An individual retirement account (IRA) is a tax-deductible way to contribute to retirement. Additionally, the growth of the funds within the account is tax-deferred. The money compounds faster, and tax is not applied to the investment until the funds are withdrawn from the account. Beware of the penalty of withdrawing funds early. A withdrawal before age 59.5 could result in a 10% penalty unless it falls within a few exceptions.
- Roth IRAs—The Roth IRA differs from the traditional IRA. There is no tax deduction on investment because contributions originate with after-tax dollars. Roth IRA holders do not pay taxes on their eventual withdrawals. There are limitations on the allowable contributions based on an individual’s or combined couple’s annual earnings.
- Simple IRA— A good option for small business owners with fewer than 100 staff members and no other retirement plan, a simple IRA allows employees and employers to make pre-tax contributions to the account.
- Traditional 401(k)— Many companies offer employees traditional 401(k) accounts. This is another pre-tax option. Like the traditional IRA, a 401(k) can grow tax-deferred. Withdrawals will incur tax, but retirees tend to fall into a lower bracket, so the amount is relatively small. The contribution limits tend to be higher than IRA accounts. Employers can also contribute to this account.
- Roth 401 (k)— This is another employer-sponsored retirement account. Like the Roth IRA, after-tax contributions are made to the account, so they are not tax-deductible, but withdrawals are tax-free. Both employees and employers can contribute to this account with limitations on the annual contribution amount. This type of account can co-exist with a traditional 401(k). Dual account holders can split their contributions to reap the benefits of both.
Build net worth
Once you estimate your future expenses, determine how much you need to retire, and achieve a balance of investments through your accounts, you can build your net worth. Net worth considers the value of your assets less your liabilities. Increased net worth will be another feather in your cap when you retire. Building net worth takes time, but it creates a long-term path with short-term goals such as:
Homeownership—Potentially your most valuable asset, your home can help you fund your retirement later in life.
Salary increases—Throughout your career, take measures to raise your salary. Assume more responsibility, develop your skills, seek additional training, and switch jobs when you feel you have reached a plateau at your current employer. With more money comes more opportunity to pay down debt and save.
Debt reduction—Debt reduces net worth. Decrease spending wherever possible to pay off existing debt and save more.
Business ownership—Business ownership isn’t for everyone, but for those with an entrepreneurial spirit, it can significantly increase their net worth. If the time comes to sell, it has the potential to yield more money for your retirement.
Securing a life insurance policy—Life insurance won’t produce money for you in retirement, but it does increase your net worth. In the event of your untimely departure, life insurance will protect your assets and loved ones.
Retirement planning is a lifelong journey you should not take alone. A financial planner can help you make wise decisions that pay later in life. With early, careful strategy and regular contributions, you can overcome the challenges that face today’s retirees. At SHP Financial, we are ready and waiting to help you get on your way to a successful retirement plan. Contact us for a free consultation.
[1] https://www.cnbc.com/guide/retirement-planning/#how-to-start-saving-for-retirement
