Figuring out the best way to save for retirement can be tricky—everyone’s financial situation is different, which can make it hard to find the right balance between saving for retirement, putting money aside for other goals, and maintaining a comfortable lifestyle.
There is a lot of retirement advice out there, but not all advice is created equal. In fact, most of the advice commonly shared about retirement savings should be altogether ignored. To help you determine which savings plan is right for you, first you have to learn what not to do. Here are five of the most frequently shared—but ultimately ill-advised—retirement advice tips.
Monthly expenses go down in retirement.
If you assume your monthly expenses will go down once you retire, you may end up not saving enough. Many people think that they will save on commuting expenses or they will no longer have a mortgage, but the reality is that the majority of retirees replace their old expanses with new ones. While you may no longer drive to work every day, you will likely still drive to volunteer or recreational activities, not to mention incur the increased costs of travel that often occur during retirement.
Also, when homeowners pay off their mortgage, they may funnel that money into new hobbies or making lifelong dreams come true. Though research has shown that about 20 percent of retirees have lower monthly expenses, another 20 percent spend more. The remaining 60 percent tend to have about equivalent monthly expenses.
People need X amount of money to retire.
Many people will offer an exact figure for how much money you need to save to be able to retire. Unfortunately, these numbers rarely reflect the truth for everyone—though you will need a significant chunk of money to retire, choosing an arbitrary number is not helpful. If you choose an amount that’s too high, you may become discouraged because you feel like you will never hit that amount. Or you may become so focused on saving enough that you forego important opportunities in the present.
In reality, future retirees need to think about how much they will likely spend each month in retirement and use that number to come up with a figure that more accurately reflects their personal goals and lifestyle preferences. Financial advisors and other professionals can help you set more realistic goals.
Social Security will run out in the next few years.
Over the years, many people have talked about how Social Security is going broke. While Social Security has been more robust in the past, it is not in imminent danger of going bankrupt. Most often, retirement professionals hear people bring this fact up when they want to draw on Social Security early (even though this involves a penalty). These people tend to want to get in on the money while they can. However, Social Security is funded through a payroll tax, so as long as people are paying their taxes, there will be benefits for retirees. Taking a permanent reduction in monthly income can cause a lot of issues down the line. While you may be tempted to hedge your bets and plan for retirement without factoring in Social Security, the truth is that this money is not running out anytime soon.
There is always time to catch up with savings.
If you have not been able to save for some reason, do not despair—there are things you can do over time to help you boost savings. However, thinking that there is always time to catch up and using that as an excuse to delay savings is unwise. When you start saving early, you maximize the benefit of compounding returns and also give yourself some leeway when it comes to investing decisions.
Individuals who start down the road put themselves at a serious disadvantage since their money will never grow at the same rate it could have if they had started earlier. Sometimes, extenuating circumstances get in the way, but you should be diligent about saving as much as possible—now.
Only one savings tool is necessary.
One of the biggest traps that people fall into is putting all of their savings into a single type of account. There are many different types of savings accounts, and they all have their unique benefits and drawbacks. You can look into other options, like an IRA, to supplement the money you put into your work-related savings accounts, such as a 401(k).
The problem with having one savings tool is that you may start to feel like you have maxed out your savings. For example, when you have gotten as much matched from your employer as possible, you may stop saving. At this point, you need to look at other options and figure out what will benefit you the most once you have achieved the maximum for an employee-sponsored account. Often, it makes sense to have at least one traditional and one Roth account, giving you options for lowering your taxes in retirement.
Nowadays, the majority of workers do not have a traditional pension that they can depend on for income once they retire. As a result, saving through a 401(k) has become more important than ever. However, maximizing your savings through this vehicle is not always as simple as it seems. You will need to pay close attention to the rules governing deposits into your account, as well as current tax policy. Otherwise, you may end up costing yourself money down the line.
Importantly, rules and policies change every year, so it is imperative that you pay close attention as you continue to save for retirement. However, there are some general tips that you should follow to maximize your savings:
1. Avoid fees
When choosing your 401(k) provider through your work, you should opt for one with the lowest or fewest amount of fees. While fees may not sound like much, they can add up quickly and significantly cut into the account value down the line, especially when accounting for compounding over time. Of course, the plan should also have the right risk tolerance. You should never feel like you have been cornered into a particular plan because of fees. If that happens, it is time to talk to human resources and consider an alternate savings plan, such as an IRA. Taking advantage of employee matches may still make sense, but once that is maxed out, another product may prove to be the best choice.
2. Diversify savings
When it comes to investing for the future, diversification is important—but many people do not understand how to do so. Diversification reduces your portfolio’s risk by making it more stable during market volatility or downturns. Financial planners recommend choosing both stocks and bonds to provide some degree of balance, as well as periodically rebalancing the portfolio to target allocations.
For example, individuals may rebalance their portfolio to reduce their investment risk as they get closer to retirement to protect the stability of their overall investment. One piece of advice that all financial planners agree with is that investors should never make impulsive changes to their risk profiles without consultation and great need.
Diversification may also mean investing in more than one 401(k) product. A Roth account can offer several benefits to people who max out their contributions to a traditional account.
3. Get matched
Perhaps the most important aspect of maximizing 401(k) savings is taking advantage of employer matching programs. Most often, employers offer 50 cents on every dollar from the employee, up to 6 percent of total pay (although the policies differ between companies). You should know exactly what your company will match and plan to take full advantage of the program. After all, matching is basically free money in your account. This matching program is an easy way to significantly boost your account and provide a larger base for further compounding in the future.
4. Get vested
Importantly, companies also have different policies on getting vested, which means that employees who leave the company too early may not get their 401(k) contributions matched. At some companies, getting vested takes as long as five or six years of service. While some will not pay out at all until an employee becomes vested, other companies will allow employees to keep a portion of their matched contributions when they leave early.
Often, becoming vested means thousands of dollars directly to the retirement fund, so it makes sense to stay as long as possible. However, you should never let the promise of getting vested drive you to stay in a bad job.
5. Rollover balances
When people do switch jobs, they have the opportunity to cash out their 401(k) plan—this is rarely a good idea. Before the age of 59 1/2, you will face a 10 percent early withdrawal penalty and you will be required to pay income tax on the balance. This can be problematic even if you want to reinvest your money in a different account rather than spend it.
Luckily, there are other options. You can choose to keep the money in the 401(k) and let it grow over the years, but it can be difficult to keep track of your different accounts from each company you have worked at. Another option is asking your former employer to transfer the balance to a new account, which helps to avoid any fees or penalties and keeps all of your retirement money in a more centralized location.
6. Take distributions
Just because you’ve finished adding to the principal of your 401(k) account does not mean that you’re finished managing your account. These accounts have required minimum distributions starting at the age of 70 1/2. At this point, you must make minimum withdrawals on an annual basis or face a hefty penalty: 50 percent of the amount that should have been withdrawn. Since you may draw on multiple accounts during retirement or you may not be retired come this age milestone, making the withdrawal can sometimes fall through the cracks and result in a significant loss. Notably, this rule only applies to a traditional 401(k) account. With a Roth 401(k), there are no mandatory annual distributions.
When people feel like they may not have enough money saved for retirement, they may think about selling their homes to reduce their monthly costs. Even those who have saved may consider downsizing their homes as a way of making the most out of the money they have in retirement. After all, retired couples often do not need the same amount of space that they once did after their children moved out and started their own families. Certainly, downsizing your home or moving to a less expensive area can save you money, but it does not always make sense to take this step during retirement. Ultimately, individuals need to think about the total costs involved with this decision and whether or not they will actually save money as a result.
The Numerous and Sometimes Intangible Costs of Selling a Home
Selling a home is a considerable investment. Often, individuals need to pay for some updates or a facelift to maximize the price that they get. In addition, sellers frequently need to pay Realtors a commission, which can total 6 percent or even more of the total sale price. Another consideration is capital gains taxes, which can take a large chunk out of earnings if individuals make a lot of money during the sale. Beyond these costs, retirees could also potentially face expenses involved in moving to a new space, which could range from purchasing or renting a new home to paying for the cost of movers. Closing costs can consume even more money. Furthermore, people often find themselves needing new, smaller furniture for a smaller living space. Other incidental costs may also arise. Another issue is the fact that people often think that their homes are worth more than they actually are.
Selling a home may also involve some intangible costs. These costs also deserve some consideration before a decision is made. Particularly when people move to a new area, they will have to say good-bye to friends, family members, doctors, community members, and others. These relationships are not easy to rebuild in a new place, which can make individuals feel somewhat lonely once they move and result in some regrets about their decision. Plus, our homes have a lot of sentimental value. People should avoid treating this decision too lightly and find themselves wishing that they had followed a different path. For many people, staying put is worth the extra expense in retirement.
When Moving to a New Home in Retirement Can Make Sense
Some people may put themselves in a better position by moving. Perhaps moving will bring them closer to family members or make it easier for them to run their weekly errands. Another important consideration relates to health. As people grow older, they may begin to experience mobility problems, which could make it appealing to move into a home with greater accessibility, such as one without stairs. Of course, individuals can often make their current homes more accessible, but the costs involved can be high, making it more appealing to find a new one. As health concerns become more serious, individuals may end up needing some assistance, which could also influence their decision to move.
Another point to keep in mind is that many retirees successfully boost their monthly retirement income by opting to downsize. According to a study published by the Boston College Center for Retirement Research, individuals who move from a $250,000 home to one that costs $150,000 can net $6,250 annually from the decision. This gain translates to an additional $520 per month, which is a lot of money for the average retiree. Of course, this number is only theoretical. Before making the decision, retirees should create a budget that takes into account utility costs, commuting expenses, insurance needs, and other monthly expenses related to both homes to figure out how much they could potentially save with the move. This figure will often make it much more clear whether or not the decision is the right one.
Choosing a Middle Path When It Comes to Relocating in Retirement
Retirees may want to consider a third option other than relocating to a new home or keeping their current one. This third option involves renting out their current home and then moving to a smaller one. The rental proceeds can help to put a lot of money in the bank without involving many of the expenses mentioned above. Of course, renting a home can also involve a number of costs, such as hiring a management company to dealing with losses if your home goes unrented for a month. However, these costs are generally much less than those involved with an outright sale, especially if the value of your home is expected to increase in the years to come.
People may choose this third option for a number of different reasons. Some may simply want to test out a smaller place while having the option to move back to their home in case they decide that they made a bad decision. Others may want to keep the home in the family so that they can will it to their heirs. Retirees may also simply not want to go through the hassle of a sale, or they may want to have the freedom to relocate easily with the security of knowing that they already own their home should something happen. As with the decision to sell, it is important to think about the expenses involved and the rent that you can potentially secure to ensure that the deal is worth the hassle.
Many people struggle when it comes to choosing the best retirement account because, in part, choosing the right account involves making predictions about the future. But how can you tell if a traditional or Roth IRA is best for you?
Roth accounts are relatively new, as they were only introduced in 1998. In the most basic sense, Roth IRAs can help you to avoid tax ramifications down the road since any contributions are made after taxes, meaning that withdrawals are not taxed. They also have a number of benefits; for instance, you are able to withdraw prior to retirement without penalty and continue making contributions after turning 70 ½ (traditional IRAs require you to take required minimum distributions starting at this age).
While these benefits may make Roth accounts sound attractive, they do not always make sense for everyone. Generally, the decision between Roth or traditional IRAs comes down to how much a person is currently making and how much that person plans to make in the future. Roth accounts make the most sense when people think that they will have a higher income in retirement than they do now, meaning that they would be taxed at a higher rate later than they are now. Individuals who expect to earn less during retirement than now typically should opt for a traditional account since it will allow them to enjoy a lower tax rate in retirement.
The Benefits of Roth Accounts for Young Earners
Typically, a Roth account makes the most sense for young workers who have not yet fully realized their earning potential. Young workers often have an effective tax rate in the low single digits, and it is highly likely that they will be in a higher tax bracket once they retire. Front-loading the tax burden makes sense for them since it will save money down the road. In addition, investments grow tax-free in Roth accounts, an important consideration for young workers as the money will likely accrue compounded interest over the course of decades. When these individuals reach retirement, they will be able to spend all the money they have accrued without worrying about paying any taxes.
However, young workers should also consider that, since their contributions are taxed, they will need to divert more of their monthly income to retirement to make the same impact as non-taxed accounts. In a sense, Roth accounts require that individuals pay both the contribution and the taxes to a retirement fund.
At the same time, if a young worker made maximum contributions to a traditional retirement fund and then invested the tax they saved into a Roth, they would likely end up paying more in taxes than if they used a Roth to begin with, due to the required tax on the investment growth.
The Primary Strategy for Older and Higher Earners
Once individuals start to approach the peak of their careers, a Roth account stops making a lot of sense. Individuals who have high salaries, and who are thus in higher tax brackets, will likely experience a lower tax rate during their retirement years. As such, they may do best to choose a traditional account, which will defer taxes for the future.
For the highest earners, this may actually prove a moot point since there are income restrictions for opening Roth accounts. In 2019, the IRS is prohibiting people from contributing to a Roth account if they earn more than $137,000 annually as a single person or more than $203,000 as a married couple. There are some strategies for getting around this rule, but people generally do not have a compelling reason to do so, especially considering that traditional IRAs do not have income caps for contributions.
Higher earners with traditional accounts can also enjoy a lower adjusted gross income (AGI). Pre-tax contributions are deducted from the AGI, whereas post-tax deposits into a Roth IRA are not. A lower AGI can help maximize the Saver’s Tax Credit for people who make contributions to traditional plans, although this credit mostly applies to individuals with modest incomes or AGIs below $64,000 for joint filers.
The Benefits of Having Both Traditional and Roth Accounts
The people who may have the most difficulty deciding between a Roth or traditional account are those in the middle of their careers. These individuals probably do not have a clear idea about their future tax status. In this case, it can make sense to contribute to both a Roth and a traditional account at the same time. This strategy is akin to hedging their bets, although individuals should note that combined contributions cannot exceed $6,000 annually or $7,000 for people over the age of 50, according to current tax law.
However, there are some other advantages to investing in both. During retirement, people may have low tax years, such as when they have significant long-term care expenses. During these years, it makes sense to take from traditional accounts. These same individuals can also have high tax years, especially with large capital gains. In these years, distributions can come primarily from Roth accounts.
When thinking about retirement, the most important thing is to start saving early. However, it’s also important to realize that saving is not enough on its own. You need to plan strategically for how you will fund your retirement years, which means considering all forms of income and how to maximize them.
When you pay into Social Security, you’ll receive a retirement benefit in an amount that depends on several factors. When you know about these factors early in your working life, you can plan around them and maximize your retirement income. And of course, even if you’re near retirement, it’s also important to understand how Social Security works, so you can pick the right time to start drawing your benefit.
What to Know about Social Security Benefits When You’re Starting Your Career
Your Social Security benefit is primarily determined by your earned income during your working years. In general, the more you earn, the higher your benefit will be. However, there is a maximum Social Security benefit. In 2019, this maximum is $2,861 per month. No one can receive more than that, but many people will end up receiving much less, mainly due to a couple of key factors. One of these key factors is their work history.
The federal government calculates the final benefit you receive based on your lifetime earnings, averaging your salary over the 35 years during which you earned the highest amount. The Average Wage Indexing Series is used to account for inflation in this calculation. However, it is critical to know that if you work fewer than 35 years, your salary is essentially considered “$0” each year that you’re short of 35. This will reduce your average salary calculation and therefore your benefit. It’s true that you only need to work for one decade to qualify for Social Security, but you’ll need to put in at least 35 years to reap the maximum benefit.
The second factor that can bring down your Social Security benefit is when you claim it. You’ll need to work until your full retirement age to get the maximum benefit. The full retirement age depends on when you were born. The government has increased the full retirement age from 65 to 67, although the increase is happening incrementally over a 22-year period that began in 2000. For people born in 1960 and later, the full retirement age is 67. Check the Social Security Administration’s chart to view your full retirement age.
That being said, you can claim your Social Security benefit at 62. However, that benefit will be lower than it would be if you waited until full retirement age. Basically, your benefit will be reduced a certain percentage for each month before your retirement age. If you were born in 1960 or later and your full retirement age is therefore 67, you can claim your benefit at age 62, but that benefit would be reduced by about 30%.
After your full retirement age, the Social Security benefit actually increases incrementally up to 70 years of age. Thus, if you want to maximize your Social Security benefits, don’t claim any until you are 70. Past 70, no further increases occur, so it’s time to cash out.
Understanding these rules early in your career can help you plan for the future effectively. However, it is important to understand that people often need to claim the benefit before reaching age 70—and that’s okay. In an ideal world, you would be able to hold off until 70, but life has a habit of getting in the way.
Similarly, it is important to maximize your earnings for 35 years, but within reason. If you take a year or two off, you may want to plan to work another year or two, so that you don’t have those zero-salary years included in your benefit calculation. The 35-year average also makes it possible to eliminate some low-earning years, such as those right after high school or college.
Your Income and Earnings in the Years Before and After Retirement
Two other important considerations have to do with the years leading up to and following retirement. One concerns penalties: people in early and full retirement have earning limits beyond which their benefit is affected. Currently, early retirees can earn $17,640 in gross wages or net earnings without penalty, but every $2 earned above this amount will result in a $1 reduction from your benefit. In the year leading up to your full retirement age, you can bring in $46,920 before you’re penalized. For every $3 earned above this amount, $1 will be subtracted from your benefit. Once you reach your full retirement age, your earnings will not affect your benefits.
The other important consideration is taxes. Up to 85 percent of your payout can be subject to federal taxes, depending on your filing status and overall income. If your combined income falls between $25,000 and $34,000 for single filers or $32,000 and $44,000 for joint filers, you’ll have to pay taxes on up to 50% of your Social Security income. Above these ranges, you’ll be taxed on 85 percent of your benefit.
Given all this, you may want to think about reducing your overall taxable income in retirement. By distributing funds evenly over the span of a few years without sudden increases, you can decrease your adjusted gross income, but this will require some planning.
How Married Couples Should Strategize for Social Security
Another important consideration is the strategies married couples should use when it comes to claiming Social Security benefits. In general, there are two primary strategies. You can claim your own benefit, or delay this claim and receive half of your spouse’s payout. Your marriage needs to be at least 10 years old to qualify for this strategy. This approach can be especially helpful if one spouse was a particularly high earner.
Generally, one spouse will begin receiving payout earlier, whether at 62 or full retirement age, while the other waits until age 70 to maximize their benefit. Typically, the spouse who earned more delays their claim.