4 Smart Retirement Decisions During Your Working Years
- Retirement savings vehicles, such as a 401(k), Traditional IRA, and annuities have different tax advantages
- Don’t forget that you need to earn a minimum of 40 credits to claim Social Security benefits
- The liquidity you need influences whether to invest in stocks, bonds, or guaranteed income
- Investing in real estate and paying off your mortgage before retirement are additional ways to reduce future retirement income needs
A comfortable retirement is in the making long before it’s time to retire. Every day you go to work and every penny that you put away lays the foundation for your golden years. At this point, a key component of your retirement plan is to focus on working and saving.
There is no right answer to what the best approach to saving for retirement during your working years is. However, having a strategy, or at least arming yourself with the knowledge of what saving tools exist, doesn’t hurt. That’s why we’re here to give you a lay of the land.
1. It’s important to be conscious of your Social Security credits.
Social Security credits are the building blocks of your benefits. Without enough credits, the Social Security Administration (SSA) has no obligation to deliver your monthly benefit check
So how many credits are enough? For retirement benefits you need 40 credits. At maximum, you can earn 4 credits per year, meaning that 10 years of work could earn you an adequate amount of retirement credits. For every $1,260 (as of 2016) you make and pay towards Social Security taxes, with slight adjustments to for inflation, you earn 1 credit, until you max out your 4 credits per year. These credits stay with you forever regardless of breaks in employment. To figure out where you stand, sign up for My Social Security, and take a look at your statement.
2. The rest of your retirement income will likely come from key retirement accounts and investments.
There’s a wealth of information out there regarding where to put your money, so it’s important to break down a few key retirement saving accounts:
- Employer Plans
- Think 401(k)s and 403(b)s. You pay into these programs directly from your paycheck, automatically. The upsides? Contributions are pre-tax, providing a tax deduction that lowers your taxable income. Tax deferral until retirement means faster and more significant growth of your savings. Even better, some employers will match contributions to the defined contribution plan.
- Traditional IRAs
- Similar tax-deferred growth is available outside of employer plans via traditional IRAs. With an IRA you direct pre-tax income into an account, allowing the sum to grow tax-deferred until withdrawal during retirement. In some cases, your IRA contributions are tax-deductible – that is if your employer doesn’t offer a retirement plan or if your adjusted gross income falls below a certain level specified each year by the IRS. One thing to note is that there are contribution limits, adjusted with inflation each year.
- Roth IRAs
- A Roth IRA functions similar to a traditional IRA except that contributions are made on an after-tax basis. What’s unique here is that the ability to contribute to a Roth depends on your level of income. If your modified adjusted gross income is below approximately $132,000 (or $194,000 for joint filers), then you’re eligible for a Roth IRA. The pros? Tax-free growth of your contributions, and no taxes on earnings once you begin withdrawing. Additionally, with a Roth there are no mandatory distributions, so you take the money out when you need, and you let it grow as long as you want.
- Income Annuities
- Annuities are another option for retirement savings as they provide tax-deferred accumulation as long as withdrawals aren’t made before age 59½. However, one annuity can differ substantially from another. For example, a variable annuity is purchased for accumulation, offering equity market exposure while limiting downside, but many have high fees. On the other hand, income annuities are used to create steady guaranteed income that lasts your entire life. These products are designed to help you deploy your assets in retirement but offer no liquidity or access to funds.
- The Personal Pension
- Your Personal Pension is backed by insurance companies that guarantee that for every dollar you contribute, you will receive a certain amount of income every month starting when you retire. Unlike an income annuity, the Personal Pension allows you to contribute incrementally, in smaller amounts and at a younger age, similar to the way you’d put aside money in your savings account or 401(k).
3. Portfolio diversification between stocks and bonds is a good thing.
When it comes to retirement planning, the big investing question is stocks vs. bonds. The answer is both, but the balance is up to you and depends on how risky you want to be with your money. Bonds are good for safety and stability. They’re a great crutch during rough times, and good for someone who needs cash within the next five years. But retirement is a long-term goal and is growing longer and longer with our increasing life expectancy. Throwing all your money into bills and bonds won’t get you the kind of growth you need. That’s why some (and often a majority) of your money should be invested in stocks. Though the stock market may be unpredictable in the short term, historically it has moved upward in the long term. With the high average return of stocks, that’s where you’ll get the biggest bang for your invested buck over the long-term.
4. Your home has significant value
A final source of money to consider in retirement is your home. Investing in real estate and paying off your mortgage before your retire means substantially reduced living expenses in retirement. Plus, the equity in your home is an asset which can generate income, through tools like a reverse mortgage.
Although there is no formulaic answer to what the best way to save for retirement during your working years is, understanding the vehicles out there to save is incredibly valuable. By determining your retirement goals these retirement saving vehicles can be utilized to get you one step closer.