The sooner you begin saving for retirement, the more time your money has to grow thanks to the power of compound interest. Each year”™s gains build on the prior year”™s gains. Compound interest is a sure, low-risk way to accumulate wealth.
Here are a few tips to keep in mind when saving for retirement:
Set realistic goals and understand your risk tolerance. Project your retirement expenses based on your needs, not rules of thumb. Be honest about how you want to live in retirement and how much it will cost. Then calculate how much you must save to supplement Social Security and other sources of retirement income.
Generally, the greater the risk, the greater the reward will be, but not everyone is comfortable taking a lot of risk. If you”™re losing sleep over your investments (e.g., if your asset allocation is 100% invested in stocks during a volatile stock market), you should probably reduce your level of risk and opt for other types of investments such as index funds.
Take advantage of a 401(k). Contributing money to a 401(k) Is one of the easiest and best ways to save for retirement. Not only does it give you an immediate tax deduction and tax-deferred growth on your savings, but for many people, it also means a matching contribution from your employer.
Contribute to an IRA. As with a 401(k), IRA contributions offer substantial tax breaks and can give your savings a tax-advantaged boost. As a reminder, there are two types of IRAs: traditional and Roth. A traditional IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you make withdrawals.
If you qualify, your contributions may be deductible. By contrast, a Roth IRA doesn”™t allow for tax-deductible contributions, but it does offer tax-free growth; i.e., you owe no tax when you make withdrawals.
Focus on asset allocation more than individual stocks. Asset allocation is dividing your investment dollars among the three main types of investment categories: stocks, bonds and cash or cash equivalents. The right mix of assets is the single most important factor in determining the overall performance of your portfolio and will significantly impact your long-term returns.
Stocks are best for long-term growth. Stocks have the best chance of achieving high returns over long periods. A healthy dose will help ensure that your savings grow faster than inflation, increasing the purchasing power of your nest egg.
Keep in mind that investing in stocks doesn”™t necessarily mean individual stock picks. You can also invest in index funds, which are a type of mutual fund or exchange-traded fund (ETF) consisting of a basket of stocks that track one of the market indices such as the S&P 500 or the Nasdaq 100.
Don”™t move too heavily into bonds, even in retirement. Many retirees stash a significant portion of their portfolio in bonds for the income. Unfortunately, over 10 to 15 years, inflation can easily erode the purchasing power of bonds”™ interest payments.
Remember, it is important to diversify your portfolio to contain different types of investments within each major asset class.
Make tax-efficient withdrawals to stretch the life of your nest egg. Once you”™re retired, your assets can last several more years if you draw on money from taxable accounts first and let tax-advantaged accounts compound for as long as possible. You can also withdraw from any investments that have lost value, then focus on selling investments held for more than a year to take advantage of lower long-term capital gains tax rates.
Work part time. Working part time after you”™ve retired benefits most people in more ways than one. It keeps you socially engaged and reduces the amount of your nest egg you must withdraw each year once you retire. In 2022, you can earn up to $19,560 without affecting your monthly social security benefit, for example.
Think outside the box. Other ways to get more mileage out of your retirement assets include relocating to an area with a lower cost of living or transforming the equity in your home into income by taking out a reverse mortgage.
While reverse mortgages are not for everyone, they can be useful for retirees who might have trouble meeting basic expenses but live in a $500,000 dollar home with no mortgage.
Consult a professional. This is a brief overview and should not be taken as specific advice. Retirement planning is a very complicated matter. Consider working with a knowledgeable professional to create a retirement plan that works best for you and your family.
Norman G. Grill is managing partner of Grill & Partners, LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien.
