Economic Policy Institute put out a survery noting that nearly half of all working-age families have not managed to save any money for retirement. However, even those families that have worked to save money for retirement have an average of just under $96,000 in their retirement accounts, a sum that is a far cry from enough to cover a person’s retirement expenses, even if they work past the current retirement age of 65 in the United States. These low numbers represent the high cost of waiting to build a retirement fund.
How Much Do You Need to Retire, Anyway?
There’s an oft-touted number when it comes to retirement: $1 million. According to experts, retirees who have managed to build up a seven-figure retirement account will be able to live “comfortably” for a 30-year retirement by withdrawing 4 percent of their savings each year after retirement. However, that would require a person to begin investing as much as $6,000 per year at an 8 percent annual rate of return in their twenties and continue that into their sixties. It’s easy to think that it’s not a big deal to start later, but waiting until you’re in your forties to start saving for retirement reduces that fund to less than $300,000 once you reach retirement age, assuming the same rate of return.
There’s a reason for this, and it’s called compound interest. When you put money into a retirement fund, it collects interest. Then, it collects interest on the new balance (the original plus the accrued interest). Rinse and repeat. This cycle is known as compounding, but it takes time. Halving the amount of time that you’re investing results in significantly less savings — as much as $1.4 million less — in your retirement fund because there was less time for interest to compound. You allow your money to work harder for you when you give it a few decades to do that work.
There are other factors to consider when it comes to saving for retirement. For example, simply putting your money into a savings account can actually cause you to lose money due to inflation. The meager amount of interest just cannot contend with how money changes value over time. Instead, invest in a 401(k) (or a similar 403(b) if you work for a nonprofit organization) or an IRA, which will fare better than the rate of inflation, even if the stock market isn’t always on the rise. This is especially true for long-term investments.
You can roughly judge the health of your retirement account based on your age. For example, a person in their forties should have at least three times their annual salary in a retirement fund. By the time you reach your fifties, that number should be closer to six times your yearly income. If you’ve fallen behind, it might be worth trying to make up the difference as much as you can.
This is where knowledge of IRS regulations comes into play. The Internal Revenue Service has specified a maximum allowed $19,500 in contributions that employees can make to their workplace 401(k). However, if you are in your fifties, you can contribute what is known as a “catch-up contribution,” which allows you to invest an additional $6,500 each year. Note that these limits apply to 2020 and have increased from 2019 by $500 each. If you also have an Individual Retirement Account, you can add $6,000 to it, for a total of $33,000 in retirement investments if you are age 50 or older.
When it comes to those who are self-employed, the maximum retirement fund contribution jumps to $57,000 in 2020 for both a 401(k) and a Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) because these people contribute as both employers and employees. This is the same amount that employees can contribute to an after-tax 401(k) if their employers allow that. This limit includes employer contributions, but employees can also make catch-up contributions in addition to this limit.
Some people may not think it’s possible to invest $18,500 — or more — per year, almost 1/5 of employees with work retirement accounts managed to contribute the maximum allotment in 2018, according to Vanguard’s “How America Saves.” It’s those people who earn more than $150,000 annually who manage to contribute the most. Sixty percent of those employees were able to contribute the maximum amount to their retirement accounts in addition to catch-up contributions.
However, even those employees who earn less than $150,000 annually may be able to contribute more to their IRAs and 401(k) by adding freelance income, volunteering for overtime. Many employees have also decided, by choice or necessity, to extend their working years. This can indeed increase savings — and decreased the number of years in retirement — if your employer matches your contribution. Working longer means you’ll wait to collect Social Security benefits, which can increase the payout.
Of course, reducing expenses enables you to contribute more to your retirement accounts. People who discover they can survive comfortably on a smaller income may also find that their nest eggs last them longer. Parents who contribute to their child’s college fund should consider whether that money would better serve them in a retirement account. While grants and scholarships can help a student achieve higher education, there are no similar programs for retirement accounts.
When Should You Start Saving for Retirement?
The short answer is always, “As soon as possible.” The more complicated answer requires you to consider how much money you’ll be able to contribute to your IRA or 401(k), how big your nest egg will need to be for you to live comfortably (which can be difficult to ascertain), and the implications of debt. Although many people would rather not have debt, there is actually both good and bad debt. “Good” debt is any debt that increases your net worth, while “bad” debt occurs when it detracts from your net value, and you do not have the cash to pay off the debt.
Paying off bad debt may be more important in the present than contributing the maximum amount of money to your retirement accounts.
Many people have found it effective to pay off the debt with the highest interest rate while making minimum payments on other debts. Once the high-interest debt is eliminated, move on to the loan with the next-highest interest rate. Continue until the debt has been eliminated. However, focusing on debt can leave you with little or even no money to contribute to your retirement funds.
Once you have no bad debt, you can begin contributing to a retirement count. Take advantage of accounts sponsored by your employer — either a 401(k) or a 403(b) if you work for a nonprofit organization, which do not tax you until you withdraw money. Another alternative to consider savings incentive match plan for employees individual retirement account, also known as a SIMPLE IRA, if your employer offers it. A Roth 401(k) may be attractive to those who can afford to pay tax on their contributions in the present because withdrawals after retirement age, currently 59 1/2 years, are often tax-free.
Employees can essentially double their savings contributions by investing the minimum amount required to activate employer retirement matching. Even if you cannot afford to make the maximum contribution allowed by the Internal Revenue Service, employer matching maximizes the overall contribution to your 401(k) or 403(b). However, if you cannot afford to contribute the minimum to your 401(k) to unlock employer matching, it’s still crucial to invest in your retirement on your own. Every little bit helps.
For those employees who can make the maximum contribution to their 401(k) or 403(b) accounts, an Individual Retirement Account can accept contributions in addition to those to the work-sponsored retirement account. An IRA or Roth IRA is also a wise move for employees who may not have access to a 401(k) or 403(b) through their employer.
In addition to these account types, you might benefit from a tool known as an in-service transfer or rollover. With an in-service transfer, you can move your retirement account to an account outside your employer, typically an Individual Retirement Account, without requiring a tax event, e.g., leaving the company or reaching the age of retirement. You can move some part or the entirety of your 401(k) to your IRA. As long as you don’t directly receive the money, rollovers should be free from tax but must be reported on taxes as non-taxable transactions. In-service rollovers often have stipulations, such as a requirement that money must enter the new account within 60 days. Some people use this as a method to “borrow” money from their retirement funds.
In-service transfers can be used to roll over retirement funds from a deceased spouse into their Individual Retirement Accounts.
Do not confuse this with an in-service or withdrawal, which means you can withdraw money from your retirement fund before you reach the age of retirement. Employees are permitted to do this once they reach 59 1/2 years of age. Extenuating circumstances such as financial hardship may qualify you to an in-service transfer without additional penalties, which is why this is sometimes called a hardship withdrawal.
Employees will be required to pay a 20% tax on any money that they receive. Approximately 70 percent of tax accounts in the United States allow in-service withdrawal when specific conditions are met.
When you are no longer with a company and neither of you contribute to the company-sponsored retirement account, you may use a direct IRA rollover to move funds from the 401(k) to an individual account that you control.
However, it’s vital to be contributing to your 401(k) and IRA well before this point if you want to enjoy your retirement.