There are many ways you can focus on saving for your retirement, but what’s most important is that you have a game plan and that you stick to it. In your retirement saving game plan, you need to look at how much you think you may need in retirement to pay all your expenses and then you need to look at what are the best vehicles that will help you get to that goal.
First step is trying to determine how much you need in your retirement account or accounts in order to retire. Let’s make a clarification before we begin. Retirement doesn’t mean when you reach 62, 65, 67, etc. It’s not necessarily an age, but a number. You need to determine how much you need to not have to work if you didn’t want to work. Everyone puts too much emphasis on working until they’re in their 60’s or 70’s to retire, when if they would focus on a number they need to retire, they may get to that number much quicker than they anticipated. Back to the number you need. A very quick and easy calculation to help you get to your number would be to calculate all your expenses for an entire year. Take that number and multiply by 25. That’s roughly a very good number to start with in your retirement plan. This number may change depending on where you are in your life. If you’re in the early stages of your life, like your 20’s, your annual expenses may not be that much. As you get into your 30’s and 40’s, you are raising children and may have higher expenses as a result. Your retirement number should be reevaluated as your life changes and expenses change. If you get in a habit of evaluating this once a year, you can make adjustments as needed.
Next, let’s discuss the best vehicles to use to get to your retirement number. There’s an order in which you should try to allocate your funds to get the best efficiency for access and taxes to your funds when you reach retirement. The first vehicle you should look at allocating funds would be your company 401k or Retirement plan. Most companies offer a type of retirement plan along with a match up to a certain dollar amount. If for some reason they do not offer a match, I would choose the next option first. We’ll discuss shortly. If your company matches, you should put in the most you can to maximize the company match. For example, the company match 50% for the first 8 percent you contribute. That means if you put in 8% of your paycheck, they will give you 4%. That’s basically free money that goes to work for your retirement. Once you know how much you need to contribute to your company retirement plan, then you need to stop until you maximize the next option.
Retirement vehicle number next, is the ROTH IRA. The advantage to a ROTH IRA is that your money goes into it after taxes, grows tax advantaged, and if you meet all the requirements, you can tax the money out tax free. This plays a huge part in creating tax efficiency when you can retire. Depending on your tax bracket when you need to withdrawal funds, you may want to mix those distributions between your taxable retirement, like your company retirement plan, and your ROTH IRA to reduce your overall tax liability some. A few stipulations you need to be aware of on a ROHT IRA, there is a limit on how much you can contribute, and there is a phase out which means if your modified adjusted gross income is in a certain range or over the range allowed, you cannot contribute to a ROTH IRA and to a company retirement plan. If you are over the limit, then you may want to choose to divert those funds back to your company retirement plan or possibly look at other options available we discuss. You may want to consult your tax professional to know if you are eligible to contribute to the Roth IRA and if so, how much you can contribute.
Before we move on to the next vehicle, now that you know you number, you know how much you need to contribute to your company retirement, you know how much to contribute to your Roth IRA, it’s time to back into your remaining balance of your retirement number. The reason we haven’t looked at how to get to your retirement number until this step is because at a bare minimum you should be contributing to your company plan to get the max match and maxing out your ROTH IRA. This is the part where you need to run some numbers, its not that bad though. Go to your internet browser and search for a retirement or investment calculator. Find a basic one that allows you to put in a monthly contribution amount and calculate based on a return it will tell you how much you should have at the end of a certain period. Add up you monthly amount you are contributing to your 401k, how much the company match is, and how much you are contributing to your ROTH. Use this as your monthly contribution amount, then choose 7% annual return which is a conservative return in the long run for market returns. Choose how ever many years until you would like to retire as the amount of time, then hit calculate to see what that number will look like. This is how much your company plan, and your Roth IRA should give you to go towards your retirement number. Subtract that calculated balance from your retirement number. This is the difference you need to make up in the next step. You can play around with numbers by simply plugging in a monthly amount at a 7% return, for the desired number of years until you want to retire. What ever that monthly amount you come up with in this exercise is how much you need to allocate towards the next step.
The last part of this equation is to use a non-retirement account that allows you to invest in stocks, bonds, mutual funds, ETF’s, etc., which is typically called a brokerage account. This account does not typically have any tax benefits. Some of the individual investments may offer some tax efficiencies or advantages, but the account in general does not. This vehicle is where you will put away that extra money you calculated that you need above and beyond what you are putting into you company retirement plan and your ROTH IRA. When you put money into this account, you can invest it in a variety of different options. I would stick to something similar to how your other funds are invested, either through a Target Retirement date fund or an asset allocation fund. This account will more than likely be the account you utilize first when you get to your retirement number especially if you reach it before you are 59 ½ years old which is what most retirement accounts require you to meet before withdrawing those funds without a penalty.
An additional option if available, some 401k plans allow for a ROTH contribution within the plan, which means your company retirement plan would allow all your contributions to be treated as a ROTH. If this is an option in your plan, it would be very advantageous for you to divert as much as you possibly can to your company plan up to the max the company allows you contribute for the ROTH option. If you’ve maxed out your 401k ROTH and qualify for the ROTH IRA, then you can divert the additional funds to it, then to the brokerage.
Other options may be of interest that can help you reach your retirement number. They may require different levels of experience and may be more complex that would require individualized conversations with your advisor or planner. Those options vary too greatly and are too difficult to apply on a general basis. If you’re interested in getting yourself on the right track for retirement and would like some more personalized assistance, you can reach out to me at the contact information on this link.