Planning for retirement is something every individual must do at some point in their working lives, preferably long before they are due to retire! Although American citizens receive retirement benefits from Social Security once they reach 67 years old, such benefits may only partially cover their monthly expenditures. If they do, they probably won’t leave much in the way of disposable income.
People are meant to enjoy their retirement to the maximum. After all, most people will have worked for 40 or more years, often delaying plans because their jobs got in the way. Planning for the future and building a nest egg for when you finally call it quits in the workplace is something everyone should do so they have a fulfilling retirement. Read this article, soak up the facts, and start planning for your future.
Contribute to a Pension Plan
Pensions have long been a cornerstone of retirement planning in the United States and the rest of the developed world. Pensions offer a structured and reliable way to save for your future, with many coming with added tax benefits, which you will soon learn about. Like with most retirement vessels, the sooner you start paying into a pension, the more likely your investment will grow, but it is never too late to begin a pension plan.
Contributing to a 401(k) or similar plan is one of the most common ways Americans save for retirement. Money paid into a 401(k) pension is tax-deductible, which can lead to substantial tax savings. For example, if you earn $50,000 per year and contribute $10,000 to your 401(k), your annual taxable income reduces to $40,000. This could lead to significant tax savings depending on your tax bracket.
Most 401(k) pension plans offer employer-matching contributions, further building your pension pot. Those extra payments effectively give you a bonus for saving for the future! A typical scenario would be your employer matching 50% of your contributions up to 6% of your salary. Someone earning $50,000 would see their employer contribute $1,500 to their 401(k) if they paid in $3,000.
Laws regarding 401(k) pensions change over time. Currently, there is a limit of $20,500 in annual contributions for individuals under the age of 50 and $27,000 per year for over 50s.
Invest in Individual Retirement Accounts (IRAs)
Individual Retirement Accounts (IRAs) come in two main types: Traditional and Roth. Payments into a traditional IRA, like a 401(k), are often tax-deductible. However, you will pay income tax on any withdrawals you make during retirement. On the other hand, contributions to a Roth IRA are made with after-tax dollars, meaning any withdrawals are tax-free.
Many people choose IRAs over a traditional pension for the flexibility they offer. There are thousands of IRAs out there, each with positives and negatives attached. Some specialize in investing the funds’ capital into the stock market, while others buy bonds—most split investments into several categories and industries to mitigate risks.
IRAs are not tied to your employer, meaning you can continue contributing to them even if you change jobs, which is likely during a typical working life. This portability ensures you continue consistently saving for retirement throughout your career.
There is a $6,000 per year contribution limit for individuals under 50 and $7,000 per annum for those 50 and older. If you were wondering how popular IRAs are, the Investment Company Institute recently published a report showing there are more than 35 million IRAs in the United States with a combined value of $11 trillion in assets!
Invest in a Diversified Portfolio
Have you ever heard the phrase, “Don’t put all of your eggs in one basket?” The term is something to remember regardless of how you save for retirement. When choosing your 401(k) or an IRA, you will often be given several choices regarding how and where your contributions are invested. For the most part, people tend to worry about volatility and risk. A plan with low volatility is less likely to lose value, but its potential growth is less, too. Conversely, an investment fund or plan with higher risk could yield higher returns.
Choose a diversified investment portfolio, and by that, we mean spread across several financial instruments and industries. Historically, stocks have offered the potential for higher returns over the long term. For example, the average annual return on U.S. stocks on the S&P 500 from 1926 to 2020 was approximately 10%. However, there were some significant peaks and troughs between those years.
Bonds are more stable than stocks but do not return as a yield as stocks, as a rule. Choosing a portfolio with a mixture of stocks, bonds, and other financial products can help protect your investment from market downturns like the 2008 financial crisis.
Many investors choose a higher risk/volatile investment strategy when they are younger and still have many years of contributions to make. Their primary focus is to increase the value of their contributions. As they approach retirement age, they switch to less volatile products to help protect the gains they made early in their retirement investments.
Saving for retirement is a financial goal everyone must have and one that you should get on board with as soon as possible. The longer you contribute and invest, the greater the chance your pension will grow and overcome the natural peaks and troughs associated with investing. In addition, the gains you enjoy are compounded, meaning that your seemingly small investment can swell to epic proportions under the right circumstances.
Refrain from jumping in and starting contributing to the first pension you find, whether that is a 401(k) or an IRA. Seek guidance from a financial advisor specializing in retirement plans, then do further research on your own. Saving for retirement is a big commitment but a necessary one.