Retirement Deeper Dive Part 3: How can I maximize my savings?
Learn strategies to make the most out of your retirement plan.
Introduction
Once you’ve selected a plan that works for your needs, it’s time to start saving. But how do you decide the best way to approach your plan for saving? You can come up with a plan to build up your savings by thinking about where you are in your career, how you can boost your savings, and how saving impacts your finances.
How much should I save?
Most financial planners suggest having 80% of your income for retirement after you stop working. If you currently make $45,000 per year, you want to save enough to take $33,280 out of your retirement every year. The reason is that usually retirees have access to social security and a lower-cost lifestyle (such as being an “empty nester”).
You should start to save for retirement as early as possible, starting around age 25. If you’re older, you should save more of your income each year.
The best way to reach your retirement goal is to save 10-15% of your annual salary. This includes any contribution received from your company.
Example: Your company matches the first 3% of contributions you make to your retirement. In this case, you would want to contribute at least 7% (your 7% plus the company match of 3% gets you to 10% for the year).
Not everyone can afford to make a 10-15% contribution to their retirement when they first start saving. Choose a number as close to 10-15% that you can afford and increase it a little each year. Increasing your savings by 1% per year gets you closer to your goal because of compound interest earned. Consider cutting unnecessary costs and putting the money you save into your retirement plan.
What are some tips for boosting my retirement savings?
Automatic Deposits
One of the easiest ways to grow your savings is through automatic, recurring deposits. These deposits can often be done by the company you use for your retirement program (such as Fidelity or Vanguard). A specific amount of your paycheck gets deposited directly into your retirement account on a regular basis.
Gradual Increases
Financial planners recommend increasing the amount saved in your retirement account each year. There are many simple ways to do this without it effecting your day-to-day budget or spending, like:
- Increasing automatic contributions by 1-2% a year;
- Saving a portion of any raise or bonus you receive;
- Saving unexpected income (lottery winnings, inheritance, property sales, etc.);
- When you pay off a loan, put the amount you were paying in your retirement account instead; and
- Setting aside a portion of your next tuition rate increase.
Catch-up Contributions
If you are at least 50 years old and have been unable to save as much as you would have liked, catch-up contributions can help. In most plans, these contributions go beyond standard limits and are meant to help older workers save more money to meet their retirement goals. Catch-up contributions are a valuable savings tool that should be taken advantage of if possible. Starting in 2024, there will be additional catch-up contributions allowed for individuals over the age of 60.
Pre- and Post-tax Mix
Consider working toward a mix of pre-tax and post-tax retirement plans to boost your savings. As mentioned earlier, retirement plans have two types of taxation based on the type of plan:
- Pre-tax plans (also called “tax deferred” plans) such as a Self-Employed retirement fund (called a SEP IRA) or a 401k allow you to deduct your contributions from your taxes now. When you retire, you have to pay taxes on your withdrawals.
Example: You put $1,000 into a pre-tax SEP IRA today. The amount grows to $4,661 in 20 years. You would deduct taxes on the $1,000 right away but you would pay taxes on the full $4,661 when you retire and take it out of the SEP IRA.
- Post-tax plans (also called “tax-exempt” plans) tax you on your contributions today, but not when you retire.
Example: You put $1,000 into a Roth IRA. The amount grows to $4,661. You would pay taxes on the $1,000 today but will not pay any taxes when you retire and take out the $4,661.
Depending on your age, it can be useful to have more savings in one over the other.
For younger business owners and employees (such as those in their 20s and 30s), post-tax plans can be appealing. This age group tends to earn less (so the value of a deduction today isn’t as high) and will have many years of compound interest that would be tax-free later.
A business owner or worker in their late 40s and older may want more pre-tax contributions to save money now. They will also want post-tax so when they retire there is some non-taxable income.
Over time, changing your methods for saving, especially with a mix of pre- and post-tax accounts, can help you save even more.
Index or Retirement Date Funds
Use index or retirement date funds and don’t make many changes. Warren Buffet, one of the nation’s most successful investors said: “If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring.”
You can manage your own retirement investments or pay someone to do it for you. Research shows some of the best investments are mutual or exchange-traded funds where a team of financial experts manage them for you. Index funds have a mix of the latest stocks and bonds that match current market trends. As the market changes, the team will take care of it for you.
Retirement date funds have managers who adjust investments based on the targeted retirement date. A fund that targets a retirement date of 2050 will have more aggressive investments now (to increase your savings) but will switch to ones that are less risky as 2050 starts to roll around (so that you don’t risk losing your savings in an economic downturn).
What else should I know?
Retirement funds get special treatment for taxes to encourage you to save for the future. It’s not surprising that it’s not easy to take your money out ahead of retirement. This is for two reasons:
- Tax credits and deductions are incentives to build retirement money over time.
- Helps you resist the temptation of taking out these funds for short-term uses or emergencies and instead keeps them safe for your future.
Generally, if you withdraw before the age of 59 ½, you will be subject to income tax on those funds plus an additional 10% penalty. For a SEP IRA or Simple IRA, the penalty is 25% if made in the first two years of joining the retirement plan.
Example: You are in the 22% tax bracket and take out $1,000 of your retirement plan. You will pay $220 in taxes plus a $100 penalty for a total of $320. This leaves you with just $680.
There are hardship allowances for early withdrawal if the account holder dies or for certain health issues, such as:
- Unreimbursed medical expenses that exceed 10% of your adjusted gross income (7.5% if your spouse is age 65 or older);
- Your cost for your medical insurance while unemployed; or
- You are disabled.
You can also have a penalty-free withdrawal of funds for a SEP IRA or Simple IRA if you plan to use the funds for college or to buy, build, or rebuild a first home.
If you have a 401(k) plan you can also loan yourself money against the amount in your 401(k). A 401(k) loan should be considered carefully since you’re borrowing against your future. Most financial advisors suggest only using a loan if it is going to be paid back within one year and you are sure that you will be able to pay it back.
Typically, you can borrow up to 50% or $50,000 of your savings, whichever is less. You will have to pay interest, but the interest goes into your account (so you are paying yourself). The origination fees (the fees to get the loan) tend to be lower than many bank loans.
Whether you choose to seek professional financial advice or take a do-it-yourself approach, it is important to develop a plan for your approach to saving for retirement. Ask yourself the following questions:
- How many more years do I have until I want to retire? This will tell you how long you have to save.
- How much money will I need in retirement? Remember, most experts recommend 80% of your annual income per year after retirement.
- How much do I need to save each year? Consider how much you will need to contribute to your retirement account(s) to reach your savings goal. You can find many examples of retirement savings calculators online to help you plan.
- How does my plan need to change over time? If you are unable to save as much as you prefer to get started, don’t worry! Start saving what you can and plan to review on a regular basis.
Remember, everyone starts somewhere when it comes to savings. Taking one step at a time and staying true to your plan will help you get closer to your goals for retirement.
Need more help?
You can sign up for one-on-one coaching with our experts at www.childcare.texas.gov. In addition to registering for business coaching, you can access free information, resources, and tools related to taxes, finances, staffing, operations, and many more topics.
Additional Resources
The Employee Retention Tax Credit
The Families First Coronavirus Response Leave Act
Disclaimer: The information contained here has been prepared by Civitas Strategies and is not intended to constitute legal, tax, or financial advice. The Civitas Strategies team has used reasonable efforts in collecting, preparing, and providing this information, but does not guarantee its accuracy, completeness, adequacy, or currency. The publication and distribution of this information is not intended to create, and receipt does not constitute, an attorney-client or any other advisory relationship. Reproduction of this information is expressly prohibited.
Questions?
If you have any questions, you can reach out to the Texas Workforce Commission Child Care Coaching Team at Coaching@ECEBizCoach.org.