Saving for retirement sometimes gets pushed to the backs of our minds, especially when we’re younger and tell ourselves that we have a really, really long time before we’ll have to think about our golden years.
However, saving for retirement means guaranteeing ourselves income to live off of when we’re older and no longer working. There are a few things we should really keep in mind to help us adequately prepare.
So Select asked Michael Powers, a Certified Financial Planner and Founder of Manuka Financial, to give us his best tips for saving for retirement. His financial planning company specializes in helping people retire early, though, his tips are applicable to everyone regardless of whether or not they want to retire at the traditional age.
Pay yourself first and automate your savings
According to Powers, you can begin building a strong nest egg for retirement by getting into the habit of paying yourself first. Paying yourself first is a strategy where you save a portion of your income before you spend anything, rather than spending first and then saving what’s left over. And, paying yourself first goes hand-in-hand with another one of Powers’ biggest retirement savings tips: automating what you save.
When you spend first and only save what’s leftover, you run the risk of overspending and not leaving much room to save. Your employer’s 401(k) plan can actually help you pay yourself first and automate your retirement savings since the money is taken out of your paycheck before it even hits your checking account — this way, you don’t even get the option to spend the money.
“It’s important to pay yourself first and automate your savings,” he said. “It’s much easier to put aside 10% or 20% [of your paycheck]before you even have the chance to spend it. The more you automate your savings, the better. And don’t forget to fully utilize your employer match. So if they match dollar-for-dollar on the first 4%, get that match so you get a 100% return on your investment.”
But if you don’t have an employer-sponsored 401(k) account, you can still use an IRA or Roth IRA account to save for retirement. The only differences are that you have to create an IRA yourself, but that takes just a few minutes if you open the account online through an investing platform like Fidelity or with a robo-advisor like Betterment. While you may not be able to have a portion of paycheck automatically whisked away into one of these retirement accounts, you can still plan to contribute a fixed amount of money each month as soon as you get paid.
Knowing your retirement number — a.k.a. the amount of money you’ll need in order to keep yourself afloat when you’re no longer working — can make a difference when it comes to how you save. A 2019 report from the Department of Labor explained that only 40% of Americans have calculated how much money they’ll need for retirement. And when you don’t know how much money you’ll need, you may not save enough and run the risk of outliving your retirement funds.
Whether you plan to retire early or retire at the traditional age, calculating how much money you’ll need to carry you through retirement is a must. Powers uses the 4% rule to help clients calculate what their retirement number would be.
“The 4% rule is this idea that over most historical 30-year time periods, it was found that you can withdraw 4% of your total investments each year and the money should last you at least 30 years,” Powers said. “So this is a good rule of thumb to start with when calculating how much you’ll need to save before you retire.”
Though, he also asserts that you should consider the lifestyle you want in retirement and adjust the 4% rule accordingly. For example, if you want to retire early, you may have to live off of just 3.5% of your investments each year rather than 4% to make the money last longer. Or, if you want to travel a lot in retirement, you might wind up withdrawing 5% of your money instead.
Now that you know why you should consider a 4% yearly withdrawal in retirement, it’s time to use that rule to figure out how much you should save before you retire.
According to Powers, you can calculate this number by estimating what your total yearly expenses in retirement would be, then subtracting how much you think you’ll receive through sources of income you expect to earn in retirement, like Social Security distributions and income from rental property. What’s left over is the amount of money you’ll need to withdraw from your savings and investments each year in order to cover all your expenses. Multiply this number by 25 (or you can divide it by 0.04) and you’ll be left with the amount of money you need to have saved before you’re able to comfortably retire.
So let’s say you think you’ll spend $50,000 per year in retirement and you expect to receive $26,000 per year in Social Security income — $50,000 minus $26,000 leaves you with $24,000, which is how much you’ll need to withdraw from your investments each year in order to fully cover your expenses. Now, $24,000 multiplied by 25 gives you $600,000, so you’ll need to have a total of $600,000 when you retire.
Starting to save for retirement as early as possible gives your money more time to grow. Time is one of the most important elements of investing. And those who start investing earlier can actually contribute less money each month to reach their goal, whereas someone who starts even 10 years later would need to invest much more each month to attain the same goal.
“The sooner the better,” Powers said. “You want the magic of compound interest to be on your side, so the sooner you can start saving something, the easier it will be down the road. If your account balance grows at a rate of 7% per year on average, it will double roughly every 10 years thanks to compound interest.”
Of course, not everyone ends up with an employer-sponsored 401(k) account immediately after college. But you can still open up a Roth IRA or a traditional IRA on your own and begin contributing to those accounts in the meantime.
And while saving hundreds of thousands — or even millions — of dollars for retirement can seem daunting, it’s important to make room to still enjoy the money you work for. Saving for retirement doesn’t mean you have to hunker down and not go out with friends or avoid spending on trips. Finding the middle ground between saving for your financial goals and spending on what you love can help you avoid financial fatigue.
“Remember that life is a balance,” Powers said. “Balance living for today while saving for tomorrow, because we don’t know if tomorrow will come, so you don’t want to not enjoy life for a day that may never happen.”