Retirement. It’s on everyone’s minds. And the road to retirement is riddled with potholes.
Of course, everyone would like to retire someday, but it seems like they keep kicking the proverbial can (retirement age) further down the road.
The retirement age in the U.S. used to be 62 years old to get full retirement benefits. Then it crept up to 65 years old, and now it’s 67. And it’ll likely continue creep up from there.
Of course, a big reason why the retirement age is increasing is because we are living longer.
But still, very few want to work, or have to work, into their 70s.
Unfortunately, millions of workers haven’t put away the first dime from their paychecks into either an Individual Retirement Account (IRA) or 401(k).
But it doesn’t have to be that way.
This article will give you everything you need to know to get on the path towards retirement.
The Secret To Retirement
The biggest secret to an early retirement is time. The earlier you start, the easier it will be to accumulate real wealth over time.
Think about this… let’s say you are 25, and early in your career. You sock away $300 per month into a retirement account (more on these in a moment). If you can get just 5% annually, you will end up with $435,000 at retirement.
5% is conservative.
If you achieved the average long-term return of the S&P 500, that $300 a month investment would dwarf into $1.6 million at retirement.
Now consider if you waited until you are 35 before you get serious about retirement. That same $300 a month savings rate would only grow to $239,000 at a 5% return, and $592,000 at 10%.
In other words, waiting a decade cost you just over one million dollars.
So, don’t delay saving for retirement.
Retirement Accounts 101
Start early. Got it. But where do I save?
That’s one of the biggest questions rookie investors have. And the answer is simple: Individual Retirement Account (IRA) and if your employer offers one (most do) a 401(k) account.
You can have both.
IRAs can be opened through a traditional financial institution or brokerage platform like Charles Schwab, TD Ameritrade, Wells Fargo, Chase, etc. Or you can go through a financial advisor who can also help you open and account and begin investing.
Now, an IRA comes in two different “flavors.” You can open a Roth IRA or a Traditional IRA.
The difference between the two is when you pay taxes. With a Roth IRA your contributions are after tax. You know the money that actually gets deposited into your account when payday comes. They’ve already pulled taxes out. This is after-tax money.
The beauty with the Roth IRA is that you pay your taxes now, so when you get to retirement you don’t have to pay any taxes. Also, your investments all grow tax free inside this account. That’s huge.
The Roth IRA is the best way to go for most individuals.
One caveat with a Roth IRA is that if you make more than $144,000 a year and file single, or over $204,000 for married couples, then you can NOT contribute to a Roth IRA.
That means you will have to opt for the Traditional IRA.
The Traditional IRA is great too, but because taxes are deferred in this account (but tax deductible depending on your income) then you will have to pay taxes when you pull this money out in retirement.
One thing to note is that if you don’t qualify for a Roth IRA, then a Traditional IRA is still great, too. Don’t think it isn’t. You’re still socking away cash for retirement, and that’s the whole goal.
Finally, there is a limit on how much you can put into these accounts each year. For 2022, that limit is $6,000.
The Only Free Lunch In Investing
Finally, let’s talk about the 401(k) account.
This is an employer-sponsored account that employees can contribute to. Even better, some employers will match your contributions up to a certain amount, or percentage.
If your employer offers this, it is free money. You’d be silly not to take advantage.
Put every single dollar you can into a 401(k) up to the company’s match, at least. It’s the closest thing you’re ever going to get to a free lunch in the financial world.
Let’s say your employer matches up to 4% of your salary dollar-for-dollar. If you make $100,000, then your $4,000 contribution turns into $8,000 — an automatic 100% return on your money. Your original contribution also reduces your taxable income. Not bad at all.
The contribution limit for 401(k)’s is also much higher than IRAs. For 2022, you can contribute up to $20,500.
If you maxed out your 401(k) and your IRA, then you would be socking away over $26,000 a year. That would definitely help you reach early retirement.
Tips To Reach Retirement
We’ve already stated the most important aspect, which is to start saving for retirement early. Get that compounding working in your favor.
It doesn’t even have to be a ton. Start with $50 a month if you have to, but just do it. It will get you in the habit of saving and you can increase your savings rate from there.
Once you’ve opened your retirement account(s) and began socking away money, then you can focus on a retirement date.
Don’t leave your retirement up in the air, as many people do. It’s important to nail down a retirement date, because this will help determine your retirement number — or the amount of money you need to have saved to reach your goal.
Everyone’s retirement number will be different. Some folks might want to travel the world in retirement, while others may want to stay closer to home to be with grandchildren. Others are totally fine fishing every day, while some just hope to retire someday.
But most people have an idea of how they will, or would like, to spend their retirement. This retirement lifestyle will be important as it will help determine how much money you’ll need each year to cover living expenses and entertainment.
So, let’s say you are 35 and you’ve squirreled away $50,000 in retirement savings so far. You want to maintain your current lifestyle, which you are able to do on an $80,000 salary.
You want to retire by 65 years old, and your house will be paid off. So, with no mortgage due, that $80,000 should be enough to enjoy a comfortable lifestyle (yes, you’ll have to adjust for inflation, but let’s keep things simple).
You expect to live to 95 years old, which is above the average life expectancy of 79 years old in the United States.
In other words, you have 30 non-working years in which you’ll need to replace about $80,000 per year of income.
Basic arithmetic says that at $80,000 a year for 30 years, you would need $2.4 million saved by 65 years old. This assumes that once you hit retirement you put all your money in cash and no longer earn any interest. This is very unlikely, as you’ll probably still earn interest on your money, but just not at the pace you were leading up to retirement.
Again, this is super conservative, but it’s better to overshoot retirement than to fall short.
So, $2.4 million needed by 65. You are currently 35 with $50,000 saved. If you average a 9% annual return (roughly what the S&P 500 has done historically), then you would need to sock away $1,025 per month to reach just over $2.4 million by the time you are 65.
Again, everyone’s situation is different, but this is a good way of figuring out how much you need to save each month in order to reach retirement. Of course, you amp up that monthly savings and you’ll be well on your way to retirement.