People save for retirement for many reasons, but the most common reasons we come across include: to avoid running out of money, to maintain or improve their lifestyle, to increase wealth—or some combination of these. Your first step in your retirement planning process should be to identify which of these reasons (or some other reason) is important to you. Then you can establish your retirement goals and efficiently craft your retirement plan. As you start looking for retirement savings tips, it is best to think about when and how to begin your retirement saving strategy.
When to Start Saving for Retirement
It is never too early to start saving for retirement. Some of the reasons you want to start saving as early as possible include:
- You are likely to live longer in retirement than you may expect.
- You may not meet your retirement goals if you begin saving too late.
- Your money has more time to compound. Compounding means returns on your money are reinvested, which increases the principal and, consequently, your rate of return over time.
Ways to Save Money for Retirement
Your retirement savings strategy will likely depend on your retirement savings account. Some of the more popular retirement vehicles available to you are:
- Traditional or Roth IRA: You can open an Individual Retirement Account (IRA) from many financial institutions. A Traditional IRA is a tax-deferred retirement plan. Your contributions may be deductible and you pay taxes when you take retirement distributions. In a Roth IRA, you contribute after-tax dollars. There is no tax deduction for your contribution. Your money can grow tax-free and, generally, you pay no tax on withdrawals after you turn 59½ years old. Both IRAs have contribution limits.
- Employer-sponsored 401(k) plan: This can be an effective retirement saving vehicle. Your employer may match a portion of your pre-tax contributions, which means you could create additional return. While for-profit companies usually offer 401(k)s, 403(b) plans are offered to employees of nonprofits as well as teachers. The 457planis an employer-sponsored, tax-favored retirement savings account for state employees similar to 401(k) and 403(b) plans. The one difference is that if you wish to withdraw retirement funds from the 457(b) before you reach age 59½, you generally won’t have to pay the 10% penalty.
- SEP IRA: A Simplified Employee Pension (SEP) IRA is generally used by small business owners and self-employed individuals. You can contribute up 25% of your income or $55,000, as of 2018. The lesser amount is the maximum you can contribute.
- SIMPLE IRA. A Savings Incentive Match Plan for Employees (SIMPLE) IRA allows small employers who have fewer than 100 employers to set up IRAs with less paperwork. Employers can choose to match employee contributions.
Ways to Increase Your Income
You may not be able to fully depend on your Social Security or pension for the funds to live comfortably during retirement. To increase available funds for retirement, consider the following ways to grow your income:
- Shareholder Dividends: If you own individual stocks you may receive cash dividends, or distributions of a portion of a company’s earnings to stockholders. Instead of simply taking the cash, you could set up a Dividend Reinvestment Plan, or DRIP, through your broker to automatically use your dividends to invest in more shares of stocks in your portfolio.
- Stock dividends: If you own individual stocks you may receive dividends, or distributions of a portion of a company’s earnings to stockholders. Dividends can be paid either in cash or by issuing stock.
- Bond coupons: If you own bonds, coupons are the semi-annual interest payment you will receive on a bond until it matures.
- Annuities: These are a form of insurance that entitle the annuitant to a series of monthly sums of money. Many investors consider annuities as an income source for their retirement years, but, in our view, they often aren’t as great as they seem. We believe investors should be cautious of using annuities to increase income.
Difference Between Income and Cash Flow
There is a distinct difference between income and cash flow and both are acceptable sources of funds. Income is money received for work or through investments like cash dividends from stock or bond coupon payments. Cash flow is the money available after expenses are paid. However, when it comes to paying for your retirement, you should be more concerned about your portfolio’s total return and after-tax cash flow instead of the fund source.
Ways to Reduce Expenses
It is reasonable to expect a higher cost of living when you retire due to rising medical costs and inflation’s effect on purchasing power. So, we suggest the following tips to help you increase your retirement savings:
- Using a budget: Itemize what you are spending your money on and where you spend it each week, month and year. Then review and decide which expenses could be eliminated or trimmed. The more you trim, the more you can stash away for retirement savings.
- Making small lifestyle changes: Over time, these can make a big difference. For example, if you eliminate buying a $5 latte from the local café and instead make coffee at home, consider depositing that money into your directly to savings. Then see how much it adds up to at the end of the month or year!
- Setting up automatic payments into your savings account: Regularly put aside a set amount of money for your savings. Bonus: the power of compounding!
Savings may not mean much unless you know what your savings are working toward, which is why it is important to set your retirement goals and expectations. This should help you to stay on track toward saving for that goal.
And don’t underestimate inflation’s impact and rising costs in later life. Remember that inflation can reduce your purchasing power over time and eat into your savings and investment returns.
How Fisher Investments Can Help
If you have questions about retirement savings or want help with your investing and retirement planning needs, request an appointment and we will be happy to discuss your situation with you.