There’s no getting around it – you need to have a nest egg saved before you reach retirement in order to generate income on which to live. Social Security won’t be enough to meet your income needs, and most people need additional funds for the surprises – good and bad – that can come along during retirement. But how much money you need to save depends on what lifestyle you would like in retirement.
So how can you get the most amount of money in your accounts before you retire without drastically changing your lifestyle?
Watch your tax brackets
Investing for a successful retirement goes hand-in-hand with the tax code. It doesn’t sound exciting, but if you understand how to match these two together, you could be adding thousands of extra dollars to your account balances over the next decade.
For example, if you are in a 12% tax marginal bracket during your working years (joint household having under $77,400 of income), then contributing to a 401(k) will have you deferring income taxes on roughly 12% of your income. But what if believe you’ll have income over $77,400 in retirement? You may find yourself paying more in taxes later than you deferred earlier in your career.
Paying more in taxes later doesn’t make financial sense – you’ll end up with less money.
In this example, it’s worth it to pay the taxes now – by using a Roth IRA or Roth 401(k) account – and not paying taxes on account withdrawals in retirement.
But what if you’re in a higher tax bracket – say the 24% bracket? Given our recent tax code changes in 2018, if you earn between $165,001 and $315,000 (married filing jointly), you’ll find yourself in the 24% bracket. Given your account balances in retirement probably won’t have you taking out $165,001-$315,000 each year, it’s safe to say deferring 24% in taxes now will be a good option as you’ll be in a lower tax bracket during retirement and may pay less in taxes.
If you find yourself in between these two income numbers ($77,400 – $165,001), then splitting your retirement savings between traditional and Roth accounts is a hedge between paying taxes now and paying them later on in life.
Don’t pay too much to invest
Once you’ve got money into your accounts, choosing your investments wisely can be the biggest determining factor in your account balances.
When I work with my clients, I tell them we can only control two things about investing – costs and taxes. We can’t control the market, but we can control how much we pay to invest in it, and by choosing appropriate investments, how much taxes they should generate.
Generally speaking, choosing an actively-managed portfolio (where you have a manager run a mutual fund and they switch investments for you), will likely be more expensive and generate more in taxes for you to pay. It can also cause your investments to fluctuate over time, which can sometimes reduce your returns.
The simplest way to grow your money is to invest in the market as a whole. The easiest way to do this is by choosing index funds that track certain stock markets. For example, the most diversified way to invest in US companies is through the S&P 500 index. Through one fund, you can invest in 500 companies at once. One of the cheapest companies who offers this investment is Vanguard. One of their investments for this approach will cost 0.03% per year (at time of print, Vanguard S&P 500 ETF, ticker: VOO). That equates to 3 cents per every $100 you invest. Compare that to a traditional actively-managed mutual fund which costs around 1% per year, and you’ll notice how much you’ll save year-on-year.
But you should also invest outside of the United States in order to be fully diversified. I’m not going to discuss this in too much detail, but you should have investments all over the world, through various mutual funds and other investments, to ensure your investments aren’t solely at risk from one country or economy.
Teaching your children “to fly”
I love my boys – they’re 9 and 6. But I treat them like birds, in the fact that my job as a dad is to help them fly in every aspect of their life.
As they get older, they can’t fly if I don’t fully “kick them out of the nest” – and then they have to learn to do it themselves. I have to do this in every aspect – both financially and otherwise. We all have to let our children be responsible for their own finances, which includes making mistakes.
While it can be hard to let our children find their way on their own, “taking them off the payroll” once they’re done with their schooling (most likely college), can be the best solution for everyone. Helping them transition to their own health insurance, car insurance, and cell phone plan – even if it is initially more expensive for them to switch – will help them understand what expenses they will have but also allow you to have more money to invest each month.
Learn to be content with what you have
Keeping up with Jones’ is the cancer of the personal finance world. The only way to prevent or get rid of it is to learn to be content with what you have, the lifestyle you can afford, and focusing on the non-material things in life.
I live in the suburbs of Chicago, and at the risk of sounding like I’m twice my age, the Winter’s get harder each year. I appreciate Spring, Summer and Fall a little more each year, and even being outside in the warm sunshine brings a bright smile to my face. That means as a family, it doesn’t take much money to entertain us during these seasons. We can be outside playing catch, enjoying a fire, or working in the yard that gets more colorful each year. By not spending money here, we can use it to save for the future and still be happy now.
But there are families near us who live in much larger houses, have fancier vacations and drive nicer cars. I’m sure you have people like this around you as well. Getting sucked into the comparison game gets expensive and can come at the detriment of a more secure retirement. By continuing to drive your paid-off car, delaying that non-essential house update and vacationing domestically, it can leave you with more money to save for the future.
Pay to free up your time to live or earn more money
I believe in leveraging my time to the utmost. For example, I have a cleaner come to my house each month and clean the whole house. In my business, I pay various people to complete tasks that take me away from working directly with clients. As my wife and I both work full-time, it allows us to spend our free time doing things we enjoy, or work longer to have more money to invest.
By freeing up time, you can give yourself room to work in your specialized field and earn more money to save. Even if you pay someone to do a task that gives you that time back, if you earn more than what you’ve paid them, you’ll come out ahead.
Even better, what if you leveraged some of that free time to start a business, or turn a hobby into a paid venture? Now you’re getting paid to do something you really enjoy, and you can either save that money for the future or use it to grow your “side hustle” into a fully-fledged business. Not all extra money comes from scrimping and “pinching pennies”. Allowing yourself time to think creatively about earning money can generate ideas which can have you earning more money than you do in your day job.
Dave Grant, CFP® is the founder of Retirement Matters, a fee-only financial planning and investment management company in Barrington, IL. He specializes in working with people looking to retire, and making their next phase of life as meaningful as possible.