Saving for retirement is a lifetime financial strategy.
No matter which season of saving you’re in, we have tips for maximizing your retirement savings and why you should care about it now!
- You can balance living for today and saving for the future with the right financial strategy that supports your goals.
- There are multiple ways to save for retirement (401ks, IRAs, and paying down debt)
- Starting your retirement savings early will give your funds time to grow and allow more flexibility with your risk tolerance.
Changing the Narrative
There are many preconceived notions about retirement:
- It’s decades away, so why care now?
- I have more pressing and immediate financial priorities. How can I still save for the future?
These questions tap into the classic financial planning dilemma: balancing living for today and saving for the future. We don’t think these things exist in a vacuum, and with the right savings/investing strategy, you can have both.
At AVID Planning, we pride ourselves on helping you find that balance through our Purpose Driven Money System. We can work together to bring a coordinated, deliberate strategy to your entire financial life—saving, spending, investing, giving, debt repayment, etc.
But sooner or later, retirement is coming, whether you’re prepared for it or not. It’s our goal to help you build a plan you feel confident about.
Invest Early And Stay in the Game
Saving a little bit for a longer period is much easier than saving a lot in a smaller time frame. If you wait until your 40s to save for retirement, you may experience a larger strain on your spending than had you started saving in your 20s or 30s.
Why? The later you save, the more you have to play catch up, meaning you might have to redirect a more significant portion of your paycheck to your retirement accounts, pinching your monthly cash flow.
More compellingly, saving early can help your money grow. This happens through compound interest, aka, the interest you earn on interest.
The Power Of Compound Interest
Say you have a savings account with $10,000. It earns 5% interest annually, and the interest compounds annually. At the end of the first year, you’ll have $10,500 in the account just for keeping the account open.
The next year, you’ll earn another $500 in interest and $50 from the initial $500, bringing your account balance to $11,050 after the second year.
We know that $50 from two years of interest doesn’t sound like much, but it adds up over time. Remember, you earn this interest whether you contribute additional funds or not.
While you may have many expenses competing for a slice of your paychecks, like living costs, student debt, taxes, and a down payment on a home, saving for the future is still possible.
The Unexpected Benefit of Paying Down Debt
We’re about to drop the mic here—we believe that paying down debt is part of saving for retirement.
You’re probably thinking, “what”? Let's dive deeper.
Saving for retirement and paying down debt are two sides of the same coin. Putting money into a Roth IRA but letting your student loan or credit card debt snowball isn’t helpful in the long run.
While your retirement savings might grow, your debt interest also grows. When you do this, one part of you rows your boat forward while the other rows backward. You won’t get anywhere fast!
That’s why having a strategic savings plan is essential. But how and where do you start?
Where Do I Start Saving For Retirement?
By now, you know how important it is to save for retirement and start saving early. So how do you make it happen?
Tax-Efficient Retirement Savings Accounts
If you’ve worked in a job with a benefits package, you’re probably familiar with a 401k. But did you know that there are more options out there? The most common types of retirement savings accounts are:
- Traditional 401k
- Roth 401k
- Traditional IRA
- Roth IRA
All of these accounts have contribution limits. In 2022, people with 401ks ages 50 and under can contribute up to $20,500. Anyone above 50 can contribute an additional $6,500 in “catch-up” contributions. If you have an IRA, the maximum contribution limit is $6,000. If you’re over 50, you can add $1,000 as the “catch-up.”
Let’s explore the nuances of each.
Employers offer and host these accounts and allow you to contribute money pre-tax. Some employers will also match your contributions up to a certain percentage.
You can typically set them up so a portion of your paycheck will go directly into the account. From there, you can select the type of assets you’d like to invest in. Pro tip: check your allocations regularly to ensure they remain aligned with your risk levels and financial goals.
Since the dollars you contribute are pre-tax, you must pay income taxes when making withdrawals.
The main difference between traditional and Roth 401ks is how they are taxed. Unlike the traditional 401k, you contribute to Roth accounts with after-tax income.
When you withdraw, you won’t have to pay taxes (assuming you follow the rules). But not every employer gives Roth options.
This is where IRAs come in.
The main difference between a traditional 401k and IRA is that anyone who earns income can open and contribute to an IRA.
An IRA allows you to invest in various assets like stocks, bonds, ETFs, mutual funds, index funds, etc. The asset menu tends to be more diverse than 401ks.
Additionally, most traditional IRAs are tax deductible (if you or your spouse has a 401k, you might not be able to deduct contributions to an IRA). So you get the benefit of decreasing your taxable income, and your money grows in the account tax deferred.
When you withdraw from a traditional IRA, it will be taxed at your ordinary income tax rate.
Like 401ks, the difference between a traditional and Roth IRA is how they are taxed.
Roth IRA contributions are not tax deductible in the year you contribute, but you won’t have to pay taxes on investment earnings or withdrawals (again, assuming you follow the rules).
The contribution limits are the same as a traditional IRA, but there’s another major difference: Roth IRAs have income limits for direct contributions.
In 2022, single filers must have an AGI of $129,000-$144,000, and those married filing jointly must be between $204,000-$214,000. If you fall outside those thresholds, you can’t contribute to a Roth IRA directly, though there are other options like Roth conversions high earners can consider.
Getting to Know Your Risk Tolerance
Every type of investment involves some amount of risk, and every investor has a unique risk tolerance.
Risk tolerance is the amount of risk you’re willing to take within your portfolio. Knowing your risk tolerance is important because the amount of risk you're comfortable with can impact the type of investments you choose.
For example, if you’re young and have many years to recover from lost funds, you might have a high-risk tolerance, which could lead you to invest more in equities versus fixed income. Equities tend to have more significant gains but can also be more volatile.
On the contrary, if you’re 60 and only a few years away from retirement, you likely have a more moderate risk tolerance as you’ll need access to your funds sooner. In that case, you might concentrate on building up the cash and fixed-income portion of your portfolio.
Your risk tolerance today might not be the same as in 10 years. It will likely change and grow with you as your priorities change, and that’s normal. Your financial advisor will help you find the right balance of investments that fit your risk tolerance, time horizon, and unique goals.
Don’t Be Scared of Commitment
Some people don’t like the idea of saving so much money in an account that they can’t access until they retire.
But don’t let that stop you from saving!
It’s all about striking the right balance between present and future needs.
While you may save a set portion for the long-term, you can also invest in other vehicles like a brokerage account that you can draw from when needed to supplement short to medium-term cash needs.
We’re Here To Help
If you’re just starting your retirement savings journey or are ready to make withdrawals, AVID planning is here to help you.
If you have questions on how to get started, what type of account would be best for you, finding your risk tolerance, etc., please set up a time to meet with us today. We’d love to work with you and help you reach your retirement financial savings goals.