Investing for retirement is something that every person should be thinking about. While it might not be easy to save due to low wages and/or high bills, the ability to put something aside for retirement is one of the most important things we can do to secure our future. There are many options available for people who want to begin investing for their retirement now. Be warned, this blog has a lot of finance jargon but take your time, look up any terms that you don’t already know and by the time you finish you’ll have a much better idea of what goes into investing for retirement.
The investing arena is filled with investors that have different needs. But one constant is the desire to provide for themselves or their families financially after retirement. Creating ongoing financial returns from investments can help create a stream of income for retirees. It is a means of securing financial freedom while no longer being in the workforce. While certain strategies might be used widely in finance, they might not be suitable for a person that is trying to gain a retirement level of income. Knowing what different options are available and why different people choose them is a great place to start ensuring the investment you choose for your retirement fits your needs.
How to Invest for Retirement
The first step in determining a strategy to investing is to figure out where you are in the process. If you are younger, you have more time to take higher risks in your investment portfolio. This is only because you still have the time to recoup any loss if an investment doesn’t work out. You also have more time to take advantage of compound interest growth. The older you get, the less time you have to recoup losses or change course, and therefore the less risk you want to see in your investment portfolio.
The most important aspect is to set aside a portion of every wage or income stream for retirement purposes every month. You’ve heard of “pay yourself first”. This is very important. No matter what else is going on your life, find a way to set aside something (even as little as $50 per month) for your retirement. The amount you can contribute will be determined by income and expenses. In general, a good rule of thumb is to save 15% of your income every year, starting at 25. But even 5-10% will create a noticeable benefit, especially if you have time on your side.
Another rule of thumb: by age 30, the goal is to have 1x your income saved for retirement and invested stocks and bonds. By age 40, it is 3x your salary saved. By 50, it jumps to 6x. And by 60, you’d be looking at having 8x your salary saved and invested for retirement.
Why Tax Deferred Accounts Are Good
Most retirement accounts are tax deferred accounts. Why are tax deferred accounts good? Two reasons:
- If you put money into a tax deferred retirement account like a 401k or IRA, that money grows tax free until you take it out. When you withdraw the money, the investment gains made on that money will be taxed at your then current tax rate. That means that if your tax rate is lower in retirement (it usually is) v. your current tax rate, it makes sense to defer paying taxes on those gains until later in life.
- When you move some of your income into a tax deferred retirement account, it lowers your overall adjusted gross income (AGI) in that year. That means you will pay lower taxes on the rest of your income that year.
Consideration must be given as to whether you are self-employed or have access to a pension pot and/or also can contribute into a voluntary contribution scheme, like a 401k.
If you work for a company and they offer a 401k plan, find out if the company matches contributions into your 401k. Many companies encourage their employees to save for retirement via the 401k program by matching up to a certain percentage of your salary. For example, 3%. But it’s called a match for a reason. It means you need to put in at least 3% of your income into the 401k retirement account in order to get their 3% match. We cannot underscore this enough: make sure to max out your 401k contributions each year. If you cannot, then at least put in up to the company match. Why? Because it is free money. The company is literally offering to match your contributions for retirement. That’s separate from your salary, bonus or equity. In other words, don’t leave free money on the table.
Individual Retirement Accounts (IRAs) are also popular for retirement investment. There two types of IRAs: Traditional IRA and Roth IRA. Both have a $5,500 contribution limit per year for 2018. Here we will provide a quick overview of the Traditional IRA. IRAs are available to both self employed and company employees. Like 401ks, Traditional IRAs have the benefit of being tax deferred for amounts up to a certain level per year, which makes them doubly advantageous.
There is also no limit to how long an investment can grow in these accounts past the age of retirement, there is a requirement to start withdrawing money by 70.5. With upfront tax deductions available as well as the tax credit deferral, the Traditional IRA is another good choice for retirement investing.
If you are self-employed there are other retirement contribution schemes available. These include a SEP IRA, i401k (Individual 401K) or Simple IRA. We will profile the SEP IRA in this section.
SEP stands for Simplified Employee Pension. With a SEP IRA, your business (not the individual) funds the account. Any small business owner with one or more employees, or a freelancer can set up a SEP Account. One of the main advantages of a SEP IRA over Traditional or Roth IRAs: your contribution limits are much higher. In 2018, the contribution limit is $58,000. That means that you can put in up to $58K in tax deferred income every year. And it doesn’t have to be the same amount every year. In a lean year, you can put in a much smaller amount. In a great year, you can load up and defer a significant amount in tax payment.
Note: if you have a side gig, be sure to check out ways to turn that side gig income into a tax cut.
Guaranteed income annuities, cash value life insurance plans, non-qualified deferred contribution plans and real estate investing all investment vehicles that are set up for investing for retirement. But be careful, some of these products carry many hidden fees. For example, some annuities will charge 50% of your premiums in the first few years as a commission fee for the salesperson. Make sure you fully understand the terms before signing up.
The main factor to remember is to consider what you have at present and how long you have to make a gain or handle a loss. The closer you are to retiring, the less risk you want to take with your investments. High-risk investing is for younger people with the time to recoup their losses in the future. Choosing solid and stable investments later in life will help to create consistent income and see you able to retire when ready, a guarantee not everyone has.