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The Golden Years: Journey to Saving for Retirement

Target group: Individuals of ages 18+ 

It goes without question that it’s important to save for retirement. To reiterate, saving for retirement will set you up to live comfortably in the days that you plan to enjoy and not have to worry about working (i.e. "The Golden Years"). Some people say that they don’t want to save for retirement because they don’t want their money to go to “waste.” This is money that you will get to see again in the future that grows over time and in the unfortunate event of death, the money goes directly to your beneficiaries (as long as you name them). Studies show that the average American waits too long to start saving for retirement. The truth is, it’s never really too early to start saving for retirement. The purpose of this article is to provide some of the retirement saving strategies out there and how they can apply in each stage of life.

When to Start Saving

It is true that it’s never really too early to start saving for retirement. However, some retirement plans cannot be started until a person reaches the age of 18. As such, my recommendation is to start saving for retirement at the age of 18. I personally started saving for retirement at the age of 23 so clearly I’m already behind. You should continue saving from age 18 all the way until you hit your target retirement age and as you get older, you should start thinking about increasing the amount you set aside for retirement. With that being said, here are some of the retirement saving strategies out there.

Retirement Saving Strategies

Retirement Saving Strategy #1: Individual Retirement Account (IRA)

An IRA is a very popular retirement savings account that allows you to put money away and gain some tremendous tax advantages. The three main types of IRAs are: deductible/traditional IRA, Roth IRA, and nondeductible IRA. The maximum amount that you can contribute to any or all of these accounts combined is $5,500 ($11,000 if you’re married). Note: the general rule of thumb is that you can double all amounts mentioned in this article if you’re married to keep things simple. A deductible IRA offers huge tax benefits (up to a $5,500 deduction), but you can only make up to a certain amount of money to qualify for one (Adjusted Gross Income no greater than $61,000). A Roth IRA gives you the benefit of withdrawing money tax-free. All of these IRA accounts grow tax-deferred which is a huge benefit. If you expect to be in a higher tax bracket when you retire, Roth might be your best bet and vice versa for traditional.

I recommend contributing to a Roth IRA account as soon as you hit age 18. So for my college students, freshman year would be an excellent time to start contributing to a Roth IRA account (assuming you have a job/have income). Even if it’s a small amount, this money grows tax-free and you don’t have to pay taxes on it when you withdraw it in retirement. If you would like to withdraw it early (i.e. before retirement which is never recommended), you have to pay a penalty. However, there is an exception to this penalty which are events such as buying a house, an emergency, medical issues, etc. The point is to keep the money in the account for as long as possible and these accounts grow at a pretty fast rate. As you get older, continue to increase your contributions until you hit the maximum limit and then contribute at the maximum limit allowed until you hit retirement.

For example, I personally have a traditional IRA account, which I use as a tax saving strategy. This helps offset my income and allowed me to save about 30% on taxes in the 2015 tax year. I will soon switch to a Roth IRA strategy once my income increases and I no longer qualify for the traditional IRA. Starting next year, I plan to contribute the maximum amount allowed ($5,500) (mix of Roth and traditional IRA) and when I get married, increase it to $11,000 a year. And my target retirement age is 60. Note: Age 59 ½ is when you can officially start withdrawing money without facing a penalty.

Retirement Saving Strategy #2: 401(k)

A 401(k) is very similar to an IRA, but it is an employer-sponsored plan (and yes you can have both a 401(k) and an IRA at the same time). The main two types of 401(k)’s are traditional (pre-tax) and Roth (after-tax). The difference between the two are extremely similar to the difference between a traditional IRA and a Roth IRA. Many companies offer a 401(k) plan where they match your contributions up to a certain limit (i.e. 50% match up to 5% of your contributions). The best strategy to use with a 401(k) is to contribute up to the maximum amount of how much your company will match you. For example, your company contributes/matches 50% up to 5% of your monthly contributions. Let’s say you invest 5% of your gross (pre-tax) income each month, your company will contribute 2.5% leaving a total of 7.5% contribution each month! The money grows tax-deferred and you can potentially take out the money early to cover necessary expenses such as an emergency. It is highly recommended to leave the money in the 401(k) account until you retire as it accumulates value at a pretty fast rate. And if you decide to leave your company, you can transfer the money to your next employer’s 401(k) plan or a similar retirement plan.

The best time to start contributing to a 401(k) plan is as soon as you get a full-time job. I currently have a Roth 401(k) and contribute to the maximum amount that my employer matches me. The match effect is the reason why I recommend contributing up to the maximum amount. As a bonus point, it’s good to be diversified. Since I have a Roth 401(k) and a traditional IRA, I am offsetting the risk that tax rates will go either up or down by the time I hit retirement. For example, if tax rates are lower in retirement than they are now, my traditional IRA benefits me more since I will be paying a lower tax rate when I withdraw the money and vice versa for when tax rates are higher.

One more point is that self-employed individuals have access to their own 401(k) plans as well, which can provide tremendous benefits. However, your average individual is not self-employed, so I won’t get too deep in the details. Just keep in mind that you don’t have to work for someone else to have a retirement plan.

Retirement Saving Strategy #3: Health Savings Account (HSA)

An HSA is a savings account that can cover your medical expenses. However, this is an account that can be invested just like any other retirement account. It provides triple tax benefits unlike any other retirement account or investment: pre-tax contributions (or you can take a tax deduction of up to $3,350), accumulates income tax-free, and the withdrawals for qualified medical expenses are nontaxable. You can use the money to pay medical expenses at any time (even before retirement). The downside: you must have a “high-deductible medical plan/insurance.” This is an excellent retirement saving strategy.

I recommend maxing out your contributions ($3,350) each year which is what I personally do. The tax advantages of this account are simply too good to pass up. The best way to use this account is to continue contributing and letting it grow until you reach retirement. Key point: The money doesn’t necessarily have to be used for medical expenses, but there are consequences for using it for non-medical expenses. If you use it for non-medical expenses before retirement, then you must pay a penalty on it on top of the withdrawals being taxable at your marginal tax rate. If you use it for non-medical expenses during retirement, then there’s no penalty, but you will have to pay taxes on it at your marginal tax rate. So the best thing to do is to leave the money in there until retirement and use it for medical expenses.

Retirement Saving Strategy #4: Permanent Life Insurance

That’s right. Life insurance can be used as a retirement saving strategy. Your average life insurance policy doesn’t have this feature, but there’s a thing out there known as permanent life insurance. The way it works is that you sign up for a policy through an insurance company, you choose how much you want to pay in premiums (i.e. $100 a month), you receive your “guaranteed death benefit” (money that goes to your beneficiaries in the event of death), and once you begin paying your premiums, your money accumulates value known as the cash surrender value (CSV) that you can take out at any time. The money grows tax-deferred in the form of dividends and other investments and as you pay premiums, your CSV grows and your “guaranteed death benefit” grows as well.

The best time to obtain this policy is when you get a full-time job. The younger you start the policy, the lower the premiums will be and the better position you’ll put yourself in. This is a retirement saving strategy since you can withdraw the CSV at any time and the CSV grows at a pretty fast rate. So $200 a month now, can lead to about $1 million in 50 years hypothetically.

Retirement Saving Strategy #5: Social Security

This is something that is probably not talked about often, but the taxes you pay that goes toward social security and Medicare is actually an investment. The taxes that you pay accumulate over time and turn into credits. The more credits you have, the more money you get to receive in retirement. The age that you can start gaining these benefits is age 65, however, it is recommended to wait until age 70 to start claiming benefits. So by paying that social security tax, you’re effectively saving for retirement and building your account. The amount you receive in retirement will depend on many other factors which include your other sources of income, health situation, dependents, etc.

How Much Should You Put Away for Retirement

How much you should put away each year in retirement depends on your age, stage in life, and other circumstances. The bare minimum that you should save for retirement each year is 10%. As a college student, it might be hard to do this, but the best way to go about it is to contribute 10% of whatever is left over from knocking out your tuition, fees, rent, and other necessary expenses. So let’s say you have $500 a month leftover that you can choose to save or invest (or spend). $50 should be put in a Roth IRA account. If you can go higher than 10%, then do it. As you get older and make more money, you should increase it from that 10%. I currently put about 20% towards retirement each year and plan to increase this as time goes on. You can also set a monetary target instead of a percentage target (i.e. I want to put $10,000 towards retirement each year). Note: I don't count social security towards the retirement contribution rate. In other words, social security should not be the only thing you rely on for retirement savings.

Conclusion

Saving for retirement is certainly not a bad thing to do. The earlier you begin to save, the better position you put yourself in when it’s time to call it quits and stop working for the rest of your life. I just mentioned five different retirement saving strategies that you can take advantage of. The choice of which strategy to use depends on your individual situation. The most ideal scenario is to have a mix of all of these. For example, you already know that you have to pay social security taxes so that’s automatically one account. Next, max out your 401(k) up to the amount your employer matches you (or higher). Next, max out your HSA. And finally, contribute to an IRA the remaining portion that is enough to hit your retirement savings goal and couple this with a permanent life insurance policy. That's a very powerful mix. So it’s really up to you on how you want to save and allocate these amounts, but just keep in mind that you should be contributing something to some or all of these accounts. Also keep in mind that there are other retirement plans out there, but the ones mentioned in this article are some of the most popular ones. In addition, most of these contribution limits increase as you get closer to retirement. As an added bonus, there is a credit out there known as the saver's credit which basically means that the IRS will pay you a certain amount of money for making contributions to your retirement account(s) if you meet certain qualifications. Who wants to work for the rest of their life? If you don’t save for retirement, then that just might be what will end up happening.

For any questions on this topic or other financial literacy topics, please feel free to contact me.

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