Americans’ retirement confidence has dropped compared with a year ago, no surprise considering the country is in a recession and the long-term economic impact of the coronavirus remains unknown.
Almost everyone faces economic trouble over the course of their career, and you can’t let these tough times affect your future as a retiree. Fortunately, you don’t have to.
There are five simple steps to take throughout your life to help ensure you’re well prepared for your later years. You can take all five of these steps now. But if you’re out of work due to the coronavirus and can’t afford them all, you can complete some while you’re waiting to get back to work, and do the rest once you’re rehired.
1. Estimate the retirement income you’ll need
First things first: The goal of investing for retirement is to ensure you have what you need to cover your costs once you have no more paychecks coming in. But it’s impossible to know how much to save until you know the amount of money you’ll have to withdraw from your investment accounts.
If you’re close to retirement, you can make a sample budget to get a clear picture of what you’ll spend. Next, determine how much you’ll get from Social Security, pension income, and any sources other than your investments. Any gap between your spending needs and income from these other sources will need to be filled by investment account withdrawals.
If you’re many years away from leaving work, it can be hard to make a budget with any accuracy, but there are other techniques to determine the income you’ll likely require.
One option is to assume you’ll need around 80% to 90% of the salary you were making right before leaving work. Figure out your final salary by using your current income and assuming a 2% annual raise (so if you make $50,000, next year you’d need $51,000, and $52,020 after that, and so on). Then, assume you’ll need about 80% of it at a minimum, and you’ll have your target number.
2. Determine how much to save to hit your goal
After you’ve determined the amount of income your investment accounts need to generate, you can estimate the size of your nest egg.
If you plan to follow the 4% rule (withdrawing that share of your investment account balance annually when you first retire and subsequently increasing withdrawals only to keep pace with inflation), figuring out how big your account balance needs to be is as simple as multiplying your desired investment income by 25.
If you’ve determined you need your investments to produce $35,000 a year in income to supplement Social Security, you’ll need $875,000 in your investment accounts. You can use an online calculator to determine how much you need to invest monthly to hit that target number.
3. Decide what kind of investment accounts to use
Once you know how much to save, the next step is to determine where to save it. For most people, it makes sense to use a tax-advantaged account such as a 401(k) or IRA.
If you have access to a 401(k) at work, investing in it is probably the easiest approach. And your employer may even match some of the contributions you make. However, if your 401(k) offers limited investment options or charges high fees, you may want to invest only enough to get the employer match and put the rest of your retirement contributions into an IRA.
You’ll also need to think about whether you want to invest in a traditional IRA or 401(k), which provides tax savings up front since you make contributions with pre-tax money, or whether you’d prefer a Roth account that takes contributions with after-tax dollars but enables money to grow tax free.
There are some substantial benefits to a Roth, including the ability to reduce potential future taxes on Social Security benefits. But it can be harder to make large contributions since you don’t get the tax break up front.
4. Automate your investments
Armed with the knowledge of how much you need to save and what account you need to save it in, you can take the most important step: setting up automatic contributions to your account.
When you establish an automatic recurring contribution for the amount necessary to hit your target savings goal (and stick with it), you ensure you’re successful. Saving isn’t something you have to actively work at; it just happens without your input.
5. Build a diversified portfolio
Finally, once your money is invested, you’ll want to put an appropriate percentage of it into the stock market based on your age. And you’ll want a diverse mix of investments that limit your risk while giving you the best chance at earning reasonable returns.
If you aren’t sure how to buy individual stocks (or your plan doesn’t allow it), investing in index funds that track the performance of the stock market is a simple approach.
Get started ASAP
Although you’ll need to save a substantial amount for your later years, you can work on it all your life. For most people, if you follow these five steps and start as early as possible, hopefully you’ll leave the working world with a hefty sum in your retirement accounts.
