Key Points
- Aim to save 15% of your yearly salary, including any employer matching contributions, for your retirement.
- Reduce your highest costs, such as housing and transportation, to free up money every month.
- Use tax-advantaged retirement funds, such as IRAs and 401(k)s, to build compounding wealth.
8 Tips to Saving for Retirement:
Retirement is the #1 financial objective for most Americans. But for many, that objective seems to rest more on ambition than on real action. About half of the people who retire at age 65 will be unable to sustain their preretirement lifestyle, according to the Center for Retirement Research at Boston College.
1. Save 15% a year
The previous guideline was that if you saved 10% of your family income each year, you could afford a secure retirement. However, some experts suggest raising it to 15%. To be clear, that includes any matching payments to a retirement plan that your employer provides on your behalf.
Longer life spans, the prospect of lower future investment returns, and the death of the pension all mean that workers need to dump more cash into their accounts.
2. Save more than 15%!
The 15% rule is based on two assumptions: you start saving in your 30s with the goal of retiring in your mid-60s.
But if you start late, you may need to save more. For example, a 40-year-old worker with no retirement savings should strive to save 25% of their family income.
Then there’s your planned retirement age. Many individuals want to escape the rat race well before they reach their 60s. How about the adherents of the FIRE (Financial Independence/Retire Early) movement, who save 40%, 50% or more of their salary with the purpose of retiring as soon as possible?
3. Save for the biggest expenses
A key to a safe retirement is to reduce your spending now so you can finance future consumption.
You’ve probably heard of financial gurus who say you might become a billionaire if you only give up your daily cappuccino. Every small amount helps (over decades of compounding), but your financial future is more likely to be decided by how much you spend on the three major areas in the average American’s budget:
- Housing: Housing costs comprise one-third of the typical budget, according to the Department of Labor. Only buy or rent the space you truly need, not in extremely pricey areas. Such actions may open up hundreds of dollars every month.
- Transportation: automobile & Driver says the price of a new automobile exceeds $50,000. Consumers are receiving larger loans and spending more time paying for their vehicles, and many consumers are still paying off a vehicle when they purchase a new one. The best way to reduce these expenses is to acquire small to mid-size fuel-efficient automobiles and keep them for 10 to 15 years. On average, a vehicle that makes it to 200,000 miles will save you $30,000, says Consumer Reports.
- Food: “The Department of Agriculture estimates that Americans waste 30% of the food they buy.” The typical family spends 13% of its budget on food, meaning approximately 4% of its yearly earnings goes into the garbage.
4. Maximize your retirement accounts
There’s more than one individual who wants you to finally retire. Uncle Sam and maybe your boss want to assist, too.
Uncle Sam steps in with accounts that have particular tax benefits. One example is an individual retirement account, IRA, available to anybody with earned income, which is a pay cheque.
Your company (or you if you are self-employed) provides additional accounts. These include 401(k)s, 403(b)s, and the Thrift Savings Plan (TSP). And your company can sweeten the pot by matching part of your contributions to your account.
What are the tax advantages of these accounts? It depends on the type:
- Traditional IRA/401(k)/403(b)/TSP: Contributions may reduce your taxable income, meaning you pay less in taxes in the year you contribute. And you won’t owe taxes each year on whatever interest, dividends, or capital gains your assets in the account earn. But if you remove money from the account, it is taxed like regular income.
- Roth IRA/401(k)/403(b)/TSP: Your contributions do not have tax advantages, but investment earnings and withdrawals are tax-free if you comply with the regulations.
These tax breaks can boost your retirement savings by tens of thousands of dollars, compared to what you’d have if you’d saved in a regular bank or brokerage account.
5. Invest for the long-term now
You can build your portfolio’s success by choosing assets that offer strong long-term returns. According to Ibbotson Associates, the compound average annualized returns of the major categories of investments from 1926 through 2019 are as follows:
- Large-cap equities (such as those in the S&P 500) : 10.2% average annualized returns
- Government bonds: 5.5% average rate of return each year
- Treasury bills (cash equivalents) 3.3% average annualized return
That’s why equities are the investment of choice here at The Motley Fool: the greater returns. And you obtain them only by purchasing an S&P 500 or entire stock market index fund, which–with one purchase–makes you a real part-owner of hundreds of the greatest firms in the world.
That being said, the stock market is volatile and unpredictable. Every few years, it will fall by 20% or more; in a decade, by 40% or more. So, if you want your money to be safer—especially if you need it in the next three to five years—it should be in cash or bonds. Not sure about the ideal blend for you? A target retirement fund has a balanced asset allocation based on your retirement date and gradually shifts to more conservative investments as you approach it.
6. Take advantage of catch-up contributions
If you’re behind on saving for retirement, your mid-50s is a good time to boost your savings. Uncle Sam agrees, which is also why those 50 and older have larger contribution limits to retirement accounts.
It is also vital to understand the programs that will greatly affect your retirement, including:
- Social Security: You may start receiving benefits at age 62, but the earlier you apply, the lower your monthly payout will be. What holds up pay? Payouts grow 6% to 8% a year, up to age 70. Studies say most Americans should wait until age 70 to collect Social Security…but regrettably, most don’t.
- Defined benefit – a pension. If you’re one of the lucky few who will get a cheque each month from your old company for the rest of your life, learn the formula and your options. Is there a greater advantage to working longer? Or may you collect the pension as a lump sum? Is the pension completely funded, or is there a possibility of a reduction in future payments?
- Medicare: Employers pay about 70 percent of the cost of health insurance. But when you quit your work, you’re on your own. Luckily, Medicare — the health insurance program for retirees — kicks in at age 65. Before you retire, find out what Medicare covers and if you need extra insurance.
7. Budget for a long retirement
Some individuals use the phrase ‘financial independence’ as a synonym for retirement. I get that, but the reality is your dependency only changes from a pay cheque to your portfolio.
Retire only when you have genuinely saved enough to do so. This is the foundation of a safe retirement. Studies show that 50% of those retiring at 65 will have to scale down their lives, while only 15% of those retiring at 70 will have to make such a sacrifice. That’s the power of saving additional years and postponing Social Security.
Another key consideration is to remove an appropriate amount each year. Interest rates on cash and bonds are at record lows, and the old 4% rule may no longer be as secure as it once was. Some studies show that 3% to 3.5% may be better, or use the percentages that establish mandated minimum distributions to figure out how much a retiree can spend each year.
Finally, evaluate your backup assets – home equity, life insurance, rental properties, and other valuable assets – that you may sell or borrow against if investment returns are lower than projected or costs greater than expected.
8. Get help with retirement planning
If you’ve gotten this far and are feeling overwhelmed, we understand how you feel. Retirement planning includes several moving elements.
If you believe you might benefit from some impartial professional counsel, you can consider engaging a fee-only financial planner. Some will actually manage your assets (and charge a portion of those assets) in addition to providing retirement analysis. Others just give the advice and charge by the hour or by the project. It’s a good idea to check in with a retirement specialist every five to 10 years, and especially just before you retire, to make sure you’re doing everything you can to enjoy the retirement you’ve always wanted.
The $23,760 Social Security bonus most retirees completely overlook (plus 7 other costly retirement mistakes)
If you are like most Americans, you may feel a little behind on retirement savings. But there are a few little-known tactics — including a Social Security “secret” — that might help improve your income and safeguard your nest egg.
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