Retirement Planning, Part 1: Saving for Retirement
Eileen St. Pierre, The Everyday Financial Planner
One of the groups hardest hit by the Great Recession were recent retirees. Many were forced into early retirement as companies cut jobs to control costs. Others saw the values of their retirement portfolios plummet right at the time when they were going to start drawing on them – would they have enough time for their portfolios to recover? They are also realizing what other older adults already know – it’s hard to generate income from a portfolio when interest rates are near zero. Hopefully the younger generation got the message. It’s time to start saving for retirement.
Nest Egg = Income needed in retirement – Guaranteed sources of income
Your nest egg is the amount of money you will need to save for retirement. First, you need to think about how much income you will need in retirement. Many financial advisors recommend 70 to 120% of your current income. That’s a pretty large range. Where you fall will depend on many factors such as:
- Your age – younger people should choose the higher end of this range
- Your lifestyle
- Your family medical history
- Employer-provided health insurance benefits
- Where you live
- Level of retirement debt
Guaranteed sources of income include Social Security, pensions, and annuities. High income earners with good (safe) pensions may not need any additional retirement savings to provide the income they need in retirement. However, most employers no longer offer pensions – they have switched to defined contribution plans like 401(k)s – so the burden shifts to employees to save more on their own.
One way to convert part of your retirement portfolio into guaranteed income is to purchase an annuity. You can see why these investments are so tempting to retirees. But you have to be careful. For more information on annuities, check out my financial column Annuities 101.
Take advantage of retirement accounts
The easiest way to save for retirement is to make it automatic. Have a certain amount taken out of your paycheck each pay period. If you have a retirement plan at work, deposit enough to at least get any employer match. Increase your contribution every time you get a raise. For 2013, you can contribute up to $17,500 ($23,000 if age 50+) in a 401(k), 403(b), and 457 plan. Your contributions will also lower your taxes.
If you do not have a retirement plan at work, open an IRA (Individual Retirement Account). You can contribute up to $5,500 ($6,500 if age 50+) for 2013.
- In a traditional IRA, you defer taxes on your contribution until it is withdrawn in retirement. This type of IRA is good for people who need the tax deduction, like those who do not itemize.
- If you don’t need the tax deduction (you have plenty of Schedule A deductions) or fall in a low income bracket, put the money in a Roth IRA. With a Roth, you invest after-tax money, so when you withdraw the money in retirement it’s tax free. Roth IRAs are good for working teenagers because they have the lowest tax rates.
- Depending on your level of income, you may still be able to contribute to an IRA if you are covered by a retirement plan at work.
Contributing to a retirement account may also qualify you for the Retirement Savings Contribution Credit, also known as the Saver’s Credit. In 2013, a single person with adjusted gross income (AGI) up to $29,500 may receive up to $1000; those married filing jointly with AGI up to $59,000 may receive up to $2000. For more information, read IRS Publication 4703.
If you’ve gotten a late start towards saving for retirement, there are some steps you can take to reach your savings goal:
- Contribute as much as you can – aim for 20%.
- Take advantage of catch-up contributions.
- Try out your retirement lifestyle – see how much you can reduce your expenses.
- Plan to work a few years longer, or take a second job. Perhaps you can turn a hobby into a part-time business.
- Aim for higher returns, but this also means you will have to accept more risk.