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A lot of people don’t really think about the importance of retirement savings until later. Perhaps this isn’t your priority in your 20s while you’re busy with other expenses. But when you’re young, time is an advantage you must utilize to increase your savings.
Saving should be a priority because it provides financial cushion during emergencies. With more time on your side, even with modest savings, your funds are bound to grow larger. This is how the concept of compound interest can work for you. When the interest you’ve earned begins earning interest itself, and keeps on doing so for years, the more your money will grow.
To reap future financial benefits, start planning your retirement savings now. This, of course, sounds easier said than done. Building savings today come with challenges that older generations didn’t worry about in the past. For one, people’s life spans are longer now, which means you must save money potentially into your 80s. And after the COVID-19 recession, which is one of worst since the Second World War, many of those who were unemployed are still struggling to recover stable sources of income. And with stagnant wages that fail to keep up with the rising inflation rate, building savings can be tough.
But whatever the challenge, it’s crucial to start taking steps to save for retirement.
High-Yield Savings Account Once you have savings, you can put them in a high-yield savings account which offers a higher interest rate. This usually pays around 20 to 25 times the national average of a standard savings account. Your money is federally insured and does not get invested in stocks and bonds. The interest rate for high-yield savings accounts are referred to as the annual percentage yield or APY. The higher the APY offered, the faster your savings will grow. You can also use this type of account for your emergency funds. If you need a higher income rate you can create a bond ladder or CD ladder to generate higher yield than ordinary savings accounts. With current low interest rates some investors also treat some dividend aristocrat stocks similarly to how they treated fixed-income in decades past.
However, note that APY on high-yield savings account can change after you sign up. If your bank advertised 2% APY, this rate may go up or down. APY adjusts in accordance with the Federal Reserve’s changing benchmark interest rate. When the COVID-19 pandemic hit the country, the Federal Reserve announced it will keep its benchmark interest rate near zero through 2023. In November 2020, the average high yield savings account paid 0.8% APY, while many large banks in the country offered a lower rate.
The exact amount varies depending on your goals, lifestyle, and needs. But as a rule of thumb, financial experts suggest saving 25 times your total annual expenses once you hit retirement. It’s considered the safe amount, which will allow you to withdraw up to 4% of your retirement savings annually.
But in reality, many people are not able to save that much. According to the Federal Reserve’s 2019 Survey of Consumer Finances (SCF), the average retirement savings for all families was $255,130, while the median retirement savings for all families was only $65,000. In relation to this, the average annual household expenditure was $63,036 in 2019, according to the Bureau of Labor Statistics. It also showed a 3% increase from 2018, which will continue to increase over the years due to inflation.
Based on these figures, Americans are not saving enough to plan for a comfortable retirement. The average retirement savings is nowhere close to the ideal amount, which should be 25 times their total annual expenditures. Without ample retirement funds, many people will not be able to maintain their current standard of living once they stop working.
Furthermore, financial services company Fidelity Investments suggest different goal amounts for savings as you age. For instance, at 30 years old, your savings should be equal to your annual income. And by the time you hit 67, your savings should be around 10 times your salary. Other financial companies may even recommend saving up to 12 times your annual income.
To assess if you’re saving enough for retirement, see the age-to-savings guide below:
How much you should save depends on factors such as how much you earn, when you intend to retire, and what kind of lifestyle you wish to sustain . And as you age, you have to think about the cost of healthcare, which can take up a large portion of your savings. In 2019, the average annual healthcare cost for 65-year old men was $135,000, while it was $150,000 for women.
65 is the common retirement age most people aim for. But according to the U.S. Census Bureau’s American Community Survey in 2019, the average retirement age varied for different states.
Retiring a bit early, say the age of 61, is an option for those who have saved enough funds. And for residents of West Virginia and other similar states, the general low cost of living may help you reach your retirement goals earlier.
Meanwhile, residents in the following states had an average retirement age of 65:
While others try to retire at 65 or earlier, many Americans, particularly Gen Xers and baby boomers, plan to work through retirement. Based on a 2019 article by Business Insider, some of these people simply want to work even if they don’t need the money, up until the age of 72. And because retiring early has it’s disadvantages, it makes sense for some people to keep working especially if they’re still in good health.
How Long People Live People have longer lifespans today compared to 60 years ago. This is largely attributed to advancements in medicine and improved living conditions. In 1940, American men had an average life expectancy of 60.8 years old, while it was 65.2 years for women.
In 2020, the Population Reference Bureau reported that American men had an average life expectancy of 76 years old, while women had an average life expectancy of 81 years old. The average life span extended by around 15 years for both men and women. But note that healthcare costs also increase as you age. The longer you live, the more money you have to save for retirement.
Once you have a job, it’s ideal to open your own retirement account. One of the most popular options is the individual retirement account (IRA), which is set up independently from an employer. IRAs come in two major types, which is the traditional IRA and the Roth IRA. Next, your company might offer access to 401(k) retirement plans. Once you get this opportunity, start contributing to your 401(k) retirement plan.
Here’s how common retirement accounts work:
Traditional IRAs use your pre-tax income to invest money. These are tax favored investment accounts that are used to invest in stocks, bonds, mutual funds, and exchange traded funds. Account owners can sell and purchase investments using a traditional IRA. You’re also not required to pay annual taxes on your investment gains. This means your money can grow on a tax deferred basis.
Contributions for a traditional IRA is tax-deductible, which means if you contribute a certain amount, your taxable income will be deducted with the same amount. For example, if you earned $65,000 a year and contributed $5,000, your taxable income will decrease to $60,000. Moreover, if you and your spouse are not covered by a retirement plan at work, your tax deduction is granted in full.
The amount you can deduct depends on your modified adjusted gross income (MAGI). For 2021, single tax payers or heads of the household cannot qualify for traditional IRA deduction if their MAGI is over $76,000. To qualify for a full deduction, your MAGI must be $66,000 or less. To qualify for partial deduction, your MAGI must be $66,000 and less than $76,000. This is based on the IRS 2021 IRA Deduction Limits page. To see required deductions for other tax categories, see the table below:
| Tax Filing Status | MAGI and Tax Deduction |
|---|---|
| Single or head of the household | $66,000 or less: A full deduction up to the amount of your contribution limit. Over $66,000 but less than $76,000: Partial deduction. $76,000 and up: No deduction. |
| Married filing jointly or qualifying widow(er) | $105,000 or less: A full deduction up to the amount of your contribution limit. Over $105,00 but less than $125,000: Partial deduction. |
| Married filing separately | $10,000 or more: No deduction. |
*If you file separately and did not live with your spouse at any time during the year, your IRA deduction is defined under the “Single” filing status.
According to the IRS, the annual contribution limit for traditional IRA in 2019-2021 is $6,000 when you’re below 50 years old, and $7,000 if you’re 50 years old and above (for catch-up contributions). The required minimum distribution limit (RMD) usually applies after you turn 72 years old. RMD is the minimum amount you must withdraw from your retirement account each year. This is based on the size of your account and your projected life expectancy.
Money in traditional IRA accounts also grow on a tax-deferred basis. This means you won’t be required to pay tax on any investments until you make a withdrawal. As a result, it allows your money to compound at a faster rate. When you withdraw, you must pay tax on the amount of money you take from the account. This will be based on your current year’s tax rate. You typically earn less income when you withdraw upon retirement. This means you’ll be in a lower tax bracket, which results in lower taxes.
Open a traditional IRA if your company does not provide retirement plans, or if you’ve reached the limit on your 401(k) annual contributions.
Avoid the Penalty Fee Do not withdraw from your IRA before the maturity date, which is before turning 59 ½ years old. Doing so will result in a 10% penalty fee, with the money being exposed to state and federal income taxes. It’s best to keep a separate emergency fund so you won’t touch your retirement savings.
Contributions for Roth IRA are comprised of after-tax dollars, which means the money you invested is not tax-deductible as long as certain conditions are satisfied. This allows your contributions to grow tax-free over time. Roth IRAs are a good option if you think your taxes will be higher upon retirement compared to your current tax bracket.
However, it comes with specific income requirements. In 2021, if you’re single or the household head, your modified adjusted gross income (MAGI) must be below $125,000 for a full contribution. If your MAGI is $125,000 but less than $140,000, you’re allowed to make a partial contribution. This information is based on the IRS 2021 Limitations Adjusted Provided in Section 415(d), etc. To see income requirements for other tax categories, see the table below:
| Tax Filing Status | Income Range for 2021 Contribution |
|---|---|
| Single or head of household | Full: Less than $125,000 Partial: Over $125,000 but less than $140,000 |
| Married and filing a joint tax return | Full: Less than $198,000 Partial: Over $198,000 but less than $208,000 |
| Married, filing a separate tax return, lived with spouse at any time during the year | Full: $0 Partial: Less than $10,000 |
You can make withdrawals on your Roth IRA anytime, as long as the account has been open for at least 5 years. Withdrawing contributions from your Roth IRA are both tax and penalty free. As long as you withdraw an amount equal to your contributions, it won’t be taxed or penalized. Roth IRA accounts also do not impose required minimum distribution (RMD) once you reach a certain age.
On the other hand, when it comes to withdrawing your account earnings, you must follow certain requirements. In order for distribution account earnings to qualify, you must be at least 59 ½ years old when the distribution occurs. Withdrawing before 59 ½ will trigger taxes and penalties. The earnings are only qualified after 5 years of opening your Roth IRA. However, you may avoid taxes and penalties if you use the money for the following purposes:
Similar to traditional IRA, you can only contribute a limited amount to your Roth IRA. According to the IRS, for 2021, you can contribute $6,000 a year to a Roth IRA if you’re under the age of 50. Likewise, if you’re 50 and above, your maximum contribution is up to $7,000.
Traditional 401(k) plans are mostly comprised of stocks, money market investments, and mutual funds that provide a diversified spread of bonds. These are retirement plans provided by employers to their workers. When you take a 401(k), it allows you to contribute a part of your pre-tax paycheck to tax-deferred investments. Like traditional IRA accounts, a traditional 401(k) plan is subject to tax deductions. Your money can also grow on a tax-deferred basis.
401(k) plans have much higher contribution limits than IRAs (limits increase a little bit every year). For 2020 to 2021, employees can contribute up to $19,500 on their 401(k) plan. If you’re 50 or older, you’re allowed a catch-up contribution of $6,500, which amounts to a total of $26,000. For those with multiple 401(k) accounts, note that your total contributions to all accounts should not exceed the limit.
Another advantage is your employer can generously match a percentage of your contributions. For instance, in 2020, the total employer and employee contributions combined cannot exceed $57,000 or 100% of your salary. But for those aged 50 and older, adding a catch up fee of $6,500 to the base limit increases it to $63,500. By 2021, the general limit for total employer and employee contributions will be set at $58,000, while it increases to $64,500 for employees aged 50 and up. The required minimum distribution limit for 401(k) plans typically applies when you reach 72 years old.
Financial advisers recommend saving at least 10% of your pay to a 401(k) retirement account. When you’re starting out, you might only contribute 3% of your salary. But as your salary increases, make sure to adjust your contributions to maximize your savings.
Avoid the Penalty Fee Again, avoid withdrawing from your 401(k) retirement plan. If you take money before turning 59 1/2, you’re subject to pay a 10% tax penalty. The withdrawn amount will also be taxed, which is counterproductive to your savings. To avoid touching your retirement funds, make sure to keep a separate account for emergency funds.
Thinking about large retirement funds may sound overwhelming. But don’t feel discouraged. Big savings start small. And often, we have to address basic habits to boost our funds. While people think it’s about cutting expenses, the goal mostly involves prioritizing the right costs.
To help you build retirement savings, here are simple things you can start practicing today:
1
Arrange Automatic Money Transfers – Once you receive your salary, a portion of your money goes directly to your savings account. If your employer doesn’t have this set up, you can easily arrange it with your bank. Automated transfers ensure you never touch your savings or retirement contributions on pay days. You’ll have dedicated savings while you only spend the money allocated for your monthly budget.
2
Prioritize Paying Large Debts – Do you have high-interest credit card debt? Make sure to dedicate a substantial portion of your salary to reduce debts. The longer you take to pay them off, the more it will eat away at your savings. This is how compounding interest can work against you; more interest accrues as your debt increases. Eliminating high-interest debt will free up your cash flow, allowing you to save more towards your retirement funds.
3
Avoid Unnecessary Costs – This is where planning a monthly budget comes in handy. Once you’ve distinguished your essential needs from discretionary cost, it’s easier to identify expenses you don’t need. Unnecessary expenses may include unused cable subscriptions and gym memberships. It’s also as simple as limiting restaurant dinners to a few times a month. While it doesn’t mean you can’t enjoy nice things, it’s better to set a limit for discretionary costs.
4
Pay in Cash Instead of Credit – If you’re a diligent spender who makes sure to clear their credit card balance, then good for you. In reality, many credit card users carry their balance from month to month. In 2019, the average American carries a credit card balance of $6,194. Again, this accrues greater interest, which becomes harder to pay off as it grows. To avoid high interest charges, make it a habit to use cash instead. Only use your credit card for planned purchases or emergencies.
5
Save Any Windfall Money – Set aside a big portion of your work and holiday bonuses. If you receive money gifts on your birthday, save them in your retirement account instead. Another significant source of savings are tax refunds. The Washington Post reported that that average tax refund in March 2020 was $3,100. This is a large amount that will significantly boost your retirement savings every year.
6
Find Ways to Increase Your Income – Increase your salary by rendering overtime work several hours per month. This way, you can earn more doing work that’s related to your current position. You can also find part-time or freelance work, just keep them outside your primary job hours. Your part-time work should not interfere with your main source of income. Others do freelance writing, graphic design, or drive an Uber or Lyft on the side. If you have things you don’t need, you can sell preloved items online. A little extra income can go a long way.
On average, U.S. households in 2019 headed by adults aged 65 and older spent around $50,220 annually. This is a bit lower than the national average across households, which was $63,036. So what do retired seniors usually spend on?
The top three largest costs retired adults spend on are housing, transportation, and healthcare. This is based on data from the 2019 Bureau of Labor Statistics’ Consumer Expenditure Survey for people aged 65 and up.
While healthcare costs increase, some costs shrink considerably or even disappear when you retire. Once you stop going to work, your spending habits evolve as your priorities change. Your risk tolerance is also lower when it comes to investments. This means you’re less likely to invest in new or unfamiliar ventures than when you were younger. Knowing your resources are now limited, you’ll prioritize costs that are more practical and beneficial at a later stage in life.
Here’s how the following expenses are affected after you retire:
Many seniors who find they didn't have enough saved for retirement are going into consulting or are working part time to help cover living costs & obtain employer-sponsored health insurance. Another option many seniors consider is a reverse mortgage, which allows them to tap the built up equity in their home tax-free while enabling them to remain living in the home.
Planning for your retirement may not sound like an urgent matter. Perhaps you have other major expenses to take care of. But the fact is, you should prioritize building emergency funds and retirement savings to secure your future. The earlier you start saving, the more money you’ll reap come retirement.
As a rule, try to save 20% of your after-tax income every month. Saving at least 20% will be enough to help you live off your saving’s interest when you retire. To maximize your savings, place your money in a high-yield savings account to earn more interest over time. It’s also ideal to open your own retirement account such as a traditional IRA. If your employer provides a 401(k) plan, make diligent contributions toward it. These accounts earn interest on a tax-deferred basis, which allows your money to compound at a faster rate.
Cultivate the habit of setting aside extra money every pay day. If you’re blessed with windfalls, make sure to set aside a significant amount toward your retirement account. While it’s alright to spend for things you want, don’t forget to save enough money for the future.
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