The Fourth Step to Freedom: Retirement Planning
First, let’s review what we’ve covered and where we’re going. There are seven steps to financial freedom. The first is to establish a budget. Once we know how much we’re spending, we can start to get out of debt, by paying back a little each month, set aside from the budget. The third step is to allocate a portion to saving also. Why? We save not just for rainy days, but the rainy day: retirement. The actuary tables have most of us now living well into our eighties. You don’t want to be working in your eighties, even if someone would hire you. We work so that one day we won’t have to. When we pay down our debt and save, we are actually extending our salary because our own money starts working for us.
Retirement Accounts are Uncle Sam’s way of telling you, you must start saving and we’ll help you by eliminating taxes now (traditional IRA) or later (Roth).
There are four (and only four) absolute requirements to save for retirement. The steps are:
1. Choose a retirement account.
2. Open a retirement account.
3. Put money into your retirement account.
4. Invest the money in your retirement account.
In choosing, you have many account options for a retirement account. Anyone who works can contribute to a regular IRA. Except for high earners, all employees can also contribute to a Roth IRA. Furthermore, many employees are eligible for a 401(k) through their for-profit employer. (State workers may qualify for a 457 plan, while those working at non-profits might have access to a 403(b) plan).
Whether you choose a Roth or a traditional IRA depends on your income level now versus later, which a financial advisor can help you figure out.
Where you open the retirement account is up to you. If you choose a full time advisor, it will cost you. But if you choose a low cost broker like Schwab, you have to do all the work. It depends on whether economics and finance interest you, because you’ll have to be spending at least an hour or two a week keeping up with what’s going on with your account, perhaps subscribing to newsletters and making decisions about where best to allocate your funds. If it sounds like a lot of work, it is. But if you choose a financial advisor, you absolutely must find a good one. There are many that simply take your money, throw it in a few mutual funds, and continue scouting for more clients. While most financial advisors should have known a financial reckoning was coming in 2008, most did not. Don’t give your money to those guys. Find one that keeps abreast of what is happening and what will most likely occur in the future as a result. Ask them what newsletters or economists they read. Ask them if they saw the financial crisis coming, and what they did for their clients in 2008 and 2009.
Now comes the tough part: you simply must start contributing as much as you can each year. If you do the math, even $5000 a year for twenty-five years with 5% interest, will only yield you $267,500 which, if you continue getting 5%, will only add $13,375 a year to your social security which is a little over $1,100 a month.
Which brings us to social security. Trust me; it won’t be enough for you to live on comfortably. You’ll need that extra income. And even $1,100 a month is $1,100 a month. In today’s dollars, you can probably count on somewhere from $400-$900 a month, because of inflation that is coming.
Then continue investing. Think about an automatic withdrawal plan, perhaps. But make sure you continue that allocated amount that gives you tax advantages (or more) and comfort in your later years.
You want to be comfortable in your old age. You don’t want to be worried about paying the utility bill. You can make sure that happens by planning for retirement now. Choose a type of account, decide where to open it, and do so by putting money in it now from your savings. Then figure out how you can put the maximum possible in each year.
We’ve only skimmed the question of how you manage your money in general. This is the topic of next month’s issue: Money management. The money you sock away in your savings and retirement accounts—what to do with it? It’s an excellent question, and the answer is not the same for everyone. If you’re younger, you can afford to take more risks. But there are general themes: diversification between different kinds of assets such as real estate and stocks and bonds, and then rules of thumb on allocating how much goes where. Stay tuned!