Retirement Savings: Exploring The Investment Factor

Retirement savings are often invested in the stock market, as this is historically the best way to build wealth. However, investing in stocks is not without risk, and it is recommended that individuals also keep some money outside of the stock market. The amount of money an individual should invest in the stock market depends on their risk tolerance and the amount of time before they need to use the money. Generally, younger people can invest a larger percentage of their retirement savings in the stock market, as they have more time to wait out market downturns.

How much to save for retirement

Retirement savings can be invested in the stock market, or in a mix of exchange-traded funds (ETFs), managed portfolios, alternatives, and tax-efficient investments. The amount of your retirement savings that should be invested in the market depends on your risk tolerance and the amount of time before you need the money. If you're already retired, you won't want to have all your savings in the market, as you won't have time to wait out any downturns. On the other hand, if you're decades away from retirement, you can afford to wait out any losses.

There are several rules of thumb to help determine how much to save for retirement. One is the "Rule of 110", which involves subtracting your age from 110 and investing that percentage of your retirement account balance in the market. There's also the "Rule of 120" and the "Rule of 100", which work in the same way. Your risk tolerance will determine which rule you should follow.

It's important to make steady progress toward saving for retirement, no matter your age. T. Rowe Price suggests the following benchmarks: by age 35, save one to one-and-a-half times your current salary; by age 50, save three-and-a-half to six times your salary; and by age 60, save six to 11 times your salary. These ranges increase with age to account for different incomes and situations.

Fidelity recommends saving 10 times your income by age 67. Their more detailed milestones are: save at least one times your salary by age 30, three times by age 40, six times by age 50, eight times by age 60, and 10 times by age 67. These milestones are based on the assumption that a person saves 15% of their income annually from age 25, invests more than 50% of their savings in stocks, and plans to retire at age 67 while maintaining their preretirement lifestyle.

Fidelity also suggests aiming to save at least 15% of your pre-tax income each year for retirement, including any employer match. This is based on their research, which indicates that most people will need to contribute this amount from an assumed starting age of 25 through to an assumed retirement age of 67, in order to support a replacement annual income rate equal to 45% of preretirement annual income (assuming no pension income).

It's never too early to start saving for retirement. The earlier you start, the more time your investments have to grow and recover from any market downturns. Even if you're not able to save 15% every year, saving something is better than saving nothing.

How to invest retirement savings

Investing your retirement savings can be a daunting task, but it is important to know what options you have to create a financially secure future. Here are some ways to invest your retirement savings:

Defined Contribution Plans

Defined contribution plans, such as 401(k)s, are now the most common type of workplace retirement plan. With these plans, employers enable employees to contribute to an individual account within the company plan, typically through payroll deduction. The main advantages of defined contribution plans include the ease of setting them up and maintaining them, the potential for employer-matching contributions, and higher annual contribution limits compared to individual retirement accounts (IRAs). However, they may have limited investment choices, high management and administrative fees, and employees might have to wait before contributing to the plan.

Individual Retirement Accounts (IRAs)

IRAs are one of the most common retirement plans, where individuals can set up an account at a financial institution to hold investments like stocks, mutual funds, bonds, and cash. IRAs offer a wide range of investment choices and allow individuals to decide how and when to get tax breaks. However, IRAs have lower annual contribution limits than most workplace retirement accounts.

Retirement Plans for Small-Business Owners and the Self-Employed

If you are self-employed or own a small business, there are retirement accounts designed specifically for you, such as the SEP IRA, solo 401(k), SIMPLE IRA, and profit-sharing plans. These plans often have higher contribution limits, more investment choices, and are relatively easy to set up. However, employer contributions may be discretionary, and setup and administrative duties can fall on the employer.

Other Options

Other special tax-advantaged accounts like health savings accounts (HSAs) and 529 education savings plans can also be used to supplement your retirement savings if you have exhausted other options.

When deciding how to invest your retirement savings, it is important to consider factors such as tax advantages, contribution limits, investment choices, and the level of control you have over your investments. It is always recommended to consult with a financial professional before making any investment decisions.

Retirement savings accounts

There are several options for retirement savings accounts, each with its own advantages and disadvantages. Here are some of the most common types of retirement savings accounts:

Individual Retirement Account (IRA)

With a traditional IRA, you can contribute up to a certain limit each year ($7,000 in 2024) and receive a tax deduction, meaning you pay less tax overall. The money in the account grows tax-free until you withdraw it in retirement, at which point you pay taxes on it. One disadvantage of a traditional IRA is the required minimum distribution (RMD), which means you have to start withdrawing a specified sum each year at age 72 and pay taxes on it.

A Roth IRA, on the other hand, is funded with post-tax income, so there's no upfront tax benefit. However, when you withdraw the money in retirement, you don't owe any taxes on it, including on the earnings. There are also income limits for contributing to a Roth IRA, which vary depending on your tax-filing status.

K) Retirement Plan

A 401(k) is a tax-advantaged plan offered by many employers. You can contribute to it with pre-tax wages, so your contributions aren't considered taxable income. The money grows tax-free until you withdraw it in retirement, at which point it becomes taxable. Many employers will match a certain percentage of your contributions, giving you extra funds for retirement.

A similar option is the 403(b) plan, which is offered by public schools, charities, and some churches. Like the 401(k), it allows you to contribute pre-tax money and offers tax-free growth.

Savings Account

A traditional savings account from a bank may not offer a great interest rate, but it does provide flexibility. You can deposit and withdraw as much as you want, whenever you need it. However, there are no tax benefits with a savings account, so any interest earned is taxed in the year it's earned.

Other Options

In addition to these main types of retirement savings accounts, there are other options to consider, such as health savings accounts (HSAs) and 529 education savings plans, which can also be used to supplement retirement savings.

Ultimately, the best retirement savings account for you will depend on your individual circumstances, including your age, income, tax situation, and financial goals. It's important to do your research and consider seeking advice from a financial professional to ensure you're making the most of your retirement savings.

When to start saving for retirement

Retirement savings are best started as early as possible, ideally in your 20s when you first leave school and begin earning paychecks. The earlier you start, the more time your money has to grow. Each year's gains can generate their own gains the next year—a powerful wealth-building phenomenon known as compounding.

For example, if you start saving for retirement at 25, putting aside $3,000 a year in a tax-deferred retirement account for 10 years and then stop saving completely, by the time you reach 65, your $30,000 investment will have grown to more than $338,000 (assuming a 7% annual return). However, if you wait until you are 35 and then save $3,000 a year for 30 years, by the time you reach 65, you will have only set aside $90,000 of your own money, which will grow to about $303,000.

While it may seem daunting to start saving for retirement in your 20s, it is important to remember that you don't need to have everything figured out right away. The most important thing is to get started and make sure you are saving something. You can begin by finding the right kind of account for your savings and choosing the investments for your account.

Financial experts advise everyone to start saving and investing for retirement as soon as they can, ideally putting away at least 10% of your income each month. This allows your retirement funds to benefit from compound interest, which is when you earn returns on investments, as well as returns on those returns. This helps money grow at a faster rate than with simple interest.

To illustrate the power of compound interest, consider the following example: if you invest $1,000 in a safe long-term bond that earns 3% interest per year, by the end of the first year, your investment will grow by $30. The next year, you will gain 3% of $1,030, which is $30.90. Fast forward to the 39th year, and your money will have grown to around $3,167. By the 40th year, your investment will be worth $3,262.04. Notice that your money is now growing more than three times as quickly as it did in the first year.

While it is ideal to start saving for retirement early, the next best time is right now. Set up an auto-contribution that you can afford today and take a look at your budget to see if there are any areas where you can cut costs and save more. If your employer offers a 401(k) plan, that is a great place to start investing due to the tax benefits. Contribute at least enough to get the full employer match if one is offered.

Remember, the longer you wait to plan and save for retirement, the more you will need to invest each month. While it may be tempting to enjoy your 20s with your full income, it will be harder to put money away each month as you get older, and you may even need to postpone your retirement.

How to maintain your lifestyle in retirement

Retirement is a time to do what makes you happy. Whether it's pursuing a passion project, spending time with family, or travelling the world, you can make this new chapter in your life exciting and fulfilling. Here are some tips to help you maintain your lifestyle and achieve your goals during retirement.

Build a Vision for Your Life After Retirement:

Start by envisioning what you want your retirement life to look like and don't be afraid to be detailed about your goals and desires. For example, if you currently enjoy travelling, will you want to maintain or increase that? Perhaps you want to help your children or grandchildren with their education or leave a charitable legacy. It's important to have a clear vision of your ideal retirement so you can work towards it.

Know Where Your Money is Coming From:

Take a financial inventory and list all your sources of income during retirement. This may include IRAs, 401(k)s, regular bank accounts, health savings accounts (HSAs), Social Security benefits, and proceeds from selling a business. Understanding your income streams will help you plan and ensure you have enough to fund your retirement goals.

Keep Track of Your Retirement Spending:

Create a budgeting spreadsheet to list your debts and projected expenses during retirement, including monthly household expenses and debt payments like a mortgage. This will help you manage your finances effectively and ensure you don't overspend.

Understand Potential Tax Implications:

Consider the impact of taxes on your income sources. Ask yourself: how is this asset taxed—as ordinary income, long-term capital gain, or is it tax-free? By understanding the tax implications, you can preserve more of your assets and have a more secure retirement.

Factor in Unplanned Events and Risks:

Think about potential risks that could affect your retirement income, such as market volatility or the cost of long-term medical care. As people age, the likelihood of costly medical expenses increases. Planning for these unforeseen events will help you avoid draining your retirement savings.

Plan Your Retirement Income Withdrawal in Phases:

View your retirement in phases to manage your portfolio and expenses more strategically. For example, in the first phase, you might have sources of income such as pension, Social Security, and required minimum distributions from workplace plans and IRAs. In the second phase, you can start accessing your longer-term investments.

Review Retirement Plans Yearly:

Retirement planning is an ongoing process. It's recommended to check in yearly to ensure your plan is on track and make any necessary adjustments. Your goals and circumstances may change over time, so regular reviews will help you stay aligned with your vision.

Bonus Tips:

• Start Saving Early: The sooner you start saving for retirement, the better. Compound interest works in your favour when you begin early, allowing you to put away less money per month.
• Save a Percentage of Your Income: Aim to save 10-15% of your income for retirement. Even if you can't save this much, remember that saving something is better than saving nothing at all.
• Utilise Employer-Based Plans: Take advantage of employer-based retirement plans like 401(k)s or Roth 401(k)s, especially if your company matches your contributions.
• Invest in a Savings Account: While a savings account may not offer the best interest rates, it provides flexibility with deposits and withdrawals, and can be useful for short-term expenses or longer-term goals.

Retirement is a time to embrace new experiences, pursue passions, and create lasting memories. With careful planning and a clear vision, you can maintain your lifestyle and achieve your goals during this exciting phase of life.

Frequently asked questions