You’ve probably thought to yourself in a not too distant past, of how young you were and that you didn’t have to worry about, save or plan for retirement. So how is that working out for you?
Just as the days fly by, years and decades fly by just as fast and before you know it, you’re wallowing in a sea of regret of why you didn’t start saving for retirement sooner. Not only did you not save any money for retirement, but you’ve racked up an insurmountable load of debt, essentially taking many steps backwards towards achieving your retirement goals. Of course, I’m guilty of this myself, but many times we try to sustain a lifestyle we cannot afford by making purchases on credit knowing we are not able to pay it off at the end of the month. Once this type of spending pattern begins, it will continue to snowball, building up ever larger debts for many years to come.
Don’t worry: Regardless of what stage in life you’re in, the good news is, it’s never too late to begin the journey towards a comfortable retirement. Don’t dwell on the past. However, you must not procrastinate for another day as I will discuss some of the most important concepts to understand and apply, when it comes to retirement planning.
Multiply by 25 Rule – This rule is a tool to give you an idea of how much to save up depending on how much you need for annual spending during your retirement years. For example, if you want to withdraw $60,000 per year, you will need to save up $1,500,000 ($60,000 X 25). However, if you can live comfortably withdrawing just $48,000 per year ($12,000 less per year), you will only need to save up $1,200,000 ($48,000 X 25). What this means is that you need to save $300,000 for every $12,000 in annual withdrawal during retirement. In other words, if you can reduce your spending by $1000 per month during retirement ($12,000 annually), it can help you avoid lots of stress of having to save significantly more during your working years. After all, it’s always easier to spend less money than to have to save up more.
Take advantage of retirement savings vehicles that have tax benefits such as employer sponsored 401K, Roth IRA and Traditional IRA Accounts.
Employer 401K Match – If you work for an employer that offers a 401K Match, always take advantage of it. If your employer will match up to 3%, then you must first contribute at least 3% of your income in order to benefit from your employer’s contribution. However, if you only contribute 2%, then your employer will only contribute 2% which means you’re leaving some free money on the table. Abandoning any amount of free money over the course of your career can mean tens of thousands of dollars in lost savings over the long term. In addition to contributing up to the amount your employer will match, you should, if possible, contribute as much more as you can afford to.
Roth IRA – Contributions to Roth IRA are not tax deductible. However, any interest, dividends or distributions earned are tax free, as long as nothing is withdrawn before the age of 59 ½ at which time it may be taxed at the federal and state level, as well as an early withdrawal penalty assessed by the IRS. There are certain situations when you can withdraw before age 59 ½ without the penalty, such as; if you are a first-time home buyer and you need some of the funds for a down payment, or, if used for higher education. The Roth IRA also has income requirements which must be met before you’re allowed to contribute.
For 2017, in order for you to qualify to contribute to a Roth IRA, your modified adjusted gross income should be < $186,000 if you are married filing jointly. However, you can contribute a reduced amount if your income is ≥ $186,000 but < $196,000. Once your modified adjusted gross income is ≥ $196,000, then you will not be able to contribute to the Roth IRA.
For single filers, your modified adjusted gross income should be <$118,000. If the income is ≥ $118,000 but <$133,000 then you’re able to contribute a reduced amount but phases out at a modified adjusted gross income of ≥ $133,000.
Traditional IRA – Traditional IRA accounts are usually tax deductible, but whether or not it is, depends on whether you have an employer sponsored 401K as well as how much your adjusted gross income is for the that particular year. There are current guidelines for 2017 listed on www.irs.gov. The annual contribution limit for a traditional IRA is $5,500 and if you’re age 50 or over, then the contribution limit increases to $6500. Now if you qualify to contribute to both a Traditional IRA and a Roth IRA, the combined contribution limit is still the same. In other words, if you’re under age 50, and you decided to contribute $3,000 to the Roth IRA, then the maximum you can contribute to the Traditional IRA is $2,500.
Compound Interest – Compound interest occurs when interest is initially added to the principal, and any future interest is then earned on principal and any previously accumulated interest. Once you understand the benefits of compounding interest, you will avoid the temptations to cash out your 401K every time you leave an employer. Any amount you cash out before the age of 59 ½ will be assessed a federal and state tax and a 10% IRS penalty which can quickly add up to a significant amount of savings considering it will also lose the effect of compounding interest for the amount that was cashed out for the life of the investment. For example, cashing out a $50,000 401K savings will only leave you with $32,500 if taxed at 25% plus a 10% penalty. It is advisable that once you leave an employer, to roll over your 401K to a traditional IRA account so you have the ability to keep track of how it’s doing as well as the benefit of not having all of your investments scattered which makes it difficult to track.
Rule of 72 – You may have heard of this term, but just in case you’re not familiar with it, it is a way to determine what length of time it will take your investment to double depending on the rate of return. For example, you invest $100 at 4%, it will take 18 years for your $100 to double into $200 (72 = 4 X 18). However, if you invest $100 at 9% interest, then it will only take 8 years to double to $200 (72 = 9 X 8). I’m not encouraging you to invest your hard-earned money on risky investments that promise high returns, but to encourage you to start your savings early as most safe investments have lower returns but takes a longer period of time to double.
Pay off all debts and credit cards – The correct way to use credit cards is to pay off the entire balance at the end of the month. Of course, there might be emergency situations where you may not be able to, but try to pay it off as early as possible. Getting in perpetual debt will only set you back on your retirement goals because the interest you’re paying every month for years and years, could be compounding your retirement savings.
Reduce Spending – This advice may sound a bit redundant but I cannot emphasize how important it is, as our monthly income is usually limited and the only way to increase your savings is to decrease your spending. There are many simple ways to gradually cut your spending such as reducing your visits to the nearest coffee shop from 3 times a day to only once in the morning. Once you’ve got that habit in control, reduce those visits from 7 times a week to only 3 or 4. It may sound like an enormous feat to conquer but if you make those changes one small step at a time, you’ll thank yourself later in retirement.
Once you’ve put these concepts to practice, you will be well on your way to a comfortable retirement.
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