Build your retirement nest egg
In previous articles, I have explained how to estimate how much you will spend each year after you stop working, and the size of the nest egg needed to support those expenses. The next step is to calculate how much you will need to save each year to reach this goal.
There are many interactive tools available to help you obtain this savings number, including one accessible through the United States Securities and Exchange Commission website. Find the one you’re most comfortable with.
Achieving your retirement goal, however, is not just about how much you save, but also How? ‘Or’ What you save it. The challenge is to determine which combination of options will produce the most benefits. Here are some suggestions.
Start now. Harness the power of compounding, which occurs when investment income generates its own income. To work it, you have to save, reinvest the gains and time. The more you save and the more time your money has to grow, the better.
Use tax-efficient accounts. Employer pension plans (eg 401k, 403b) and IRAs are powerful tools for building wealth because of the special tax treatment they receive. Contributions and income grow tax-sheltered or even tax-sheltered for years to come, increasing your chances of building up a substantial retirement nest egg. These accounts come in two versions, Traditional and Roth. Generally, contributions to traditional accounts can reduce taxable income and, therefore, your tax bill. In addition, investment income is tax-deferred until it is withdrawn. Roth contributions, on the other hand, are not tax deductible, but earnings and withdrawals during retirement are tax-free, provided you meet certain basic conditions.
Prioritize how you use your savings. If your employer plan offers a matching contribution, save at least the amount your employer will contribute. It is “free” money, and it will grow tax free. You won’t get a better deal anywhere. If you don’t get a match with an employer, or you’ve already taken full advantage of it and still have extra savings, then pay off any high-interest debt. Interest and unpaid finance charges are continually added to your balance, so the power of compounding works against you, creating a snowball effect. After a match with the employer, eliminating this debt will offer an excellent return on investment.
For any additional savings, consider adding more funds to your tax-advantaged retirement accounts. Whether you add to your employer’s plan or to an IRA depends on what you qualify for and your personal circumstances. If you are eligible to contribute to either one, consider funding your IRA first. This gives you the benefits of tax-efficient growth and a wider choice of low-cost investment options than most employer-sponsored plans. If you decide to fund your IRA to the limit and have even more savings, continue to fund your 401 (k) up to the maximum allowed. After that, direct all retirement savings into a taxable brokerage account.
There are many ways to save for retirement. Now that you have a sensible plan in place, it’s time to put that plan into action!
This article is intended for general information purposes only and is not intended to provide specific advice on individual financial, tax or legal matters. Please consult the appropriate professional regarding your specific situation before making any decisions.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.