7 Easy Steps to Building Retirement Account Balances
Whether you start saving for retirement at the age of 20, 30, or even 40, the key to long-term success is consistently putting money away over time. The younger you are, the less urgent retirement seems, yet the younger age will give you more years to contribute, resulting in smaller required contributions to reach your goal.
When you automate the process, and find small contributions within the existing budget, you will find investment accounts growing without feeling the pain of financial deprivation, which often sabotages efforts to save. Here are a few key ways to find extra money even with a tight financial budget.
Capitalize on Raises or Promotions. Most everyone wants to earn more. The cost of living rises each year. You have more expenses as you pay off college debt, start a family, or buy a home. Raises, promotions, and new employment opportunities provide a way to earn more over time, and open the door to higher levels of retirement contributions.
With each increase in wages, raise the amount you set aside in your 401K or IRA. Increasing your savings level by 1% at each promotion can make a dramatic difference over time to account balances without feeling a financial sacrifice. That extra 1% on a $50,000 salary translates to an extra $500 per year in pre-tax funds, which is less than $10 a paycheck. Over the course of 20 years, it can add up to nearly $20,000 at a 6% growth rate. Make this one percent increase each year for 30 years adding approximately $47,000 thousand of dollars to your nest egg.
Redirect Windfalls. Bonuses, tax refunds, inheritance, and winnings can increase balances and make up for times when you slow down contributions. Increasing Traditional IRA contributions with this year’s tax refund can increase the refund amount, giving you more to set aside for long-term retirement goals. The pre-tax nature of 401Ks can also make efficient use of a bonus if you direct that into your retirement account. You will owe fewer taxes on the bonus because it will transfer into your 401K before the IRS gets their cut, lowering the taxable portion of the bonus check.
Max Out Your Match. The company match is equivalent to free money. 94% of employers offering a 401K also match those contributions. The most common scenario is a dollar for dollar match up to 6% of salaried income. Most companies do not offer additional money for variable pay such as commissions or bonuses. The trend encourages employees to contribute to the 401K plan and builds a stronger retirement for those choosing to participate.
The structure for employer contributions varies across employers, but the impact is the same, faster growth of your money. If an employer matches dollar for dollar up to 6%, when you contribute 6%, 12% of your salary goes into the 401K account. A 50% match up to 6%, would result in 9% contribution for your 6%. In a scenario where you earn a $50,000 salary, you would add an extra $3,000 per year at the dollar match and $1,500 at the 50% match. Over 20 Years adding $3,000 per year to your balance adds up to an additional $117,000 to your retirement nest egg.
Pay Attention to Vesting Schedules. Companies offer some employee benefits subject to a vesting schedule. It is common for the employer 401K match, company stock purchases, and pensions to require meeting a set vesting schedule to gain 100% of the benefit. If you leave the company before completing the required years of service you forfeit part or all of the benefit. When a vesting schedule is in place, you must add the loss of benefits, stock value or pension to the cost of a change in employment, before accepting another offer.
Lower Investment Account Fees which reduce gains. Most 401K investments involve mutual funds, which charge fees to operate the fund. These fees are not consistent across funds and impact the rate of return. Whether you purchase mutual funds in a 401K, another work plan, or an individual IRA, all funds charge fees. The key to lowering fees is to compare fees with the historical rate of return to choose the investments with the best value. For example, target-date funds tend to charge the highest fees while index funds often charge the lowest because you do not pay for an active fund manager.
IRAs give you more control over fees because you can choose from a larger pool of investments. However, there are more opportunities to pay fees along the way. In an IRA, you may pay trading fees, broker fees, annual account fees, and other expenses which reduce the overall rate of return.
Keep an Eye on Penalties. Like fees, penalties reduce returns, though not directly. A penalty lowers the amount of money you keep, as opposed to reducing the annual return on the account. The most common penalty with retirement accounts is an early withdrawal penalty paid for accessing funds before reaching 59 ½. A traditional IRA or 401K also requires distributions to begin at the age of 70 ½, which could result in a 50% penalty for failing to take the required withdrawals. Tapping early into retirement funds might cost you a 10% penalty on top of required taxes, which can lead reduce available funds up to 50%.
Other penalties commonly seen in IRAs and Annuities is a penalty or fee charged when you sell out of a fund too soon. Buying B share mutual funds or annuity contracts require you to remain in the particular investment for a certain number of years to avoid a penalty or sales charge. If you are unhappy with the investment, you can avoid the penalty with a transfer to a different fund within the fund family, rather than selling out of the investment.
Find Everyday Savings. Look at monthly expenses and find places where you can spend money wiser. Are you paying for services you do not use? Review your auto debits and re-evaluate their value. Also, review spending habits for additional savings. Redirect any found savings to a 401K or IRA account.
Savings for retirement offers a lifetime of financial security. Carefully considering where you can capture additional funds to pay for that long-term investment, without impacting your current quality of life, is one of the keys to successful retirement planning.