Saving for Retirement
Determine your retirement income needs
Use your current expenses as a starting point, but note that your expenses may change dramatically by the time you retire. If you're nearing retirement, the gap between your current expenses and your retirement expenses may be small. If retirement is many years away, the gap may be significant, and projecting your future expenses may be more difficult.
Remember to take inflation into account. The purchasing power of a dollar declines each year as prices rise. And keep in mind that your annual expenses may fluctuate throughout retirement. For instance, if you own a home and are paying a mortgage, your expenses will likely drop if the mortgage is paid off by the time you retire. Other expenses, such as health-related expenses, may increase in your later retirement years. A realistic estimate of your expenses will tell you about how much annual income you may need to live comfortably.
Once you have estimated your retirement income needs, take stock of your estimated future assets and income. These may come from Social Security, a retirement plan at work, a part-time job, and other sources. If estimates show that your future assets and income will fall short of what you may need, the rest will have to come from additional personal retirement savings.
Figure out how much you'll need to save
- At what age do you plan to retire? The younger you retire, the longer your retirement will be, and the more money you'll need to carry you through it.
- What kind of lifestyle do you hope to maintain during your retirement years?
- What is your life expectancy? The longer you live, the more years of retirement you'll have to fund.
- What rate of growth can you expect from your savings now and during retirement? Be conservative when projecting rates of return.
- Do you expect to dip into your principal? If so, you may deplete your savings faster than if you just live off investment earnings. Build in a cushion to guard against these risks.
Build your retirement fund: Save, save, save
impulsive or unwise spending that will threaten your savings plan. If possible, save more than you think you'll need to provide a cushion.
Consider the various savings tools
If you are eligible, traditional IRAs may enable you to lower your current taxable income through deductible contributions. Withdrawals, however, are taxable as ordinary income (except to the extent you've made nondeductible contributions). Roth IRAs don't permit tax-deductible contributions but allow you to make completely tax-free withdrawals under certain conditions. With both types, you can typically choose from a wide range of investments to fund your IRA.
Annuities are generally funded with after-tax dollars, but their earnings grow tax deferred (you pay tax on the portion of distributions that represents earnings). There is also no annual limit on contributions to an annuity. However, withdrawals may be subject to surrender charges.
You have several options for saving for your retirement. Here's one approach to consider:
First contribute to employer-sponsored retirement plans, at least enough to get the full company match
- Employer match is "free" money (you may forfeit the match if you don't work for a given length of time)
- Dollars grow tax deferred until withdrawn
- Contributions are deducted from your paycheck — you may hardly notice
- Most plans allow pre-tax contributions resulting in an immediate savings
- Certain plans may allow after-tax Roth contributions — they are tax free when withdrawn, and earnings are tax free if the distribution is "qualified"
- Investment choices might be limited
Then contribute to IRAs
- Many investment options
- Traditional IRA contributions may or may not be tax deductible; Roth IRA contributions are made with after-tax dollars
- Dollars grow tax deferred until withdrawn
- Roth IRA contributions are tax free when withdrawn, earnings are tax free if the distribution is "qualified"
Other options: annuities, stock plans, life insurance, other investments (e.g., stocks, mutual funds), non-qualified deferred compensation, salary continuation plans
- Annuities, life insurance, and other options have unique tax advantages
- Current lower capital gains tax rates make some equity investments attractive for retirement planning
- Some options may be complex, and the timing of taxable events may be difficult to control