Managing retirement savings during turbulent markets
Morgan Stanley private wealth adviser Mary Deatherage joins Barron’s Roundtable to discuss what retirement savings options will help generate income in a low-yield environment.
Saving for retirement is a monumental task, requiring several decades of diligent effort. Some people hope to circumvent that by playing the lottery or trying to bet on the right investments, but these get-rich-quick schemes rarely pan out. That doesn't mean there aren't secrets to growing your wealth, though.
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Below, I outline three tricks to help reach retirement faster and hold on to more cash. To be clear, these "secrets" still require effort on your part, but they can help make the task a little less arduous.
1. The sooner you begin saving for retirement, the easier it is
The only good reasons to put off saving for retirement are if you need all your income to cover your living expenses or if you're using your extra cash to pay down high-interest debt or build an emergency fund. Once those are out of the way, retirement should be your top priority. Why? Because every month you delay, you're costing yourself money.
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Consider this: Your goal is to save $1.5 million for retirement and you hope to retire at 65. If you began saving once you turned 25, you'd only need to save about $627 per month, assuming a 7% annual rate of return. But if you waited just six months to start saving, you'd now have to set aside $674 per month, assuming the same annual rate of return, to hit your goal. That's an extra $47 per month.
Over the course of your working life, you'd end up contributing about $300,960 of your own money if you began saving at 25. But if you waited until 25 1/2, you'd have to contribute $319,476 of your own funds, all because you decided to put off saving for retirement for six months. And you could cost yourself a lot more than $19,000 if you waited even longer.
You might not be able to afford to make large contributions, especially right now, but even small contributions can grow into significant amounts over time. Set aside what you can for retirement each month, even if it's only a few dollars. This will get you into the habit, and then as you're able to free up more cash for retirement, you can increase your contributions.
2. Choosing the right retirement account can help you save on taxes
Retirement accounts are treated differently, depending on whether they're tax-deferred or Roth accounts. Tax-deferred contributions, including contributions to most 401(k)s, reduce your taxable income this year, but then you owe taxes on your distributions in retirement. This is the smarter way to go if you think you're in a higher tax bracket today than you will be once you retire. By delaying taxes until you're in a lower tax bracket, you'll owe a smaller percentage of your savings to the government.
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Roth accounts work the opposite way. You pay taxes on your initial contributions, but then you don't owe taxes on your distributions in retirement. These accounts make more sense if you believe you're in the same or a lower tax bracket today than you will be once you retire. By paying taxes now, you'll lose a smaller percentage on a smaller amount of money, and then you'll get to avoid taxes on earnings.
The tricky thing about all this is that there's no way to predict how your income or the tax brackets might change between now and your retirement. All you can do is make an educated guess. Some people choose to hedge their bets by having some of each type of savings. If you do this, favor one or the other based on which you think will offer you the best tax benefits.
3. Health savings accounts are a great place to stash retirement savings
Most people don't think of health savings accounts (HSAs) as retirement savings vehicles, but they're actually one of the best. Money you contribute to an HSA reduces your taxable income for the year, like contributions to tax-deferred retirement accounts, and if you use the money for medical expenses at any age, you won't owe taxes on it at all. Once you reach 65, you can use the money for nonmedical expenses, too, but you'll owe income tax if you do this. You can actually withdraw money for nonmedical expenses before 65, but you'll pay a 20% penalty.
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HSAs are not subject to required minimum distributions (RMDs) like tax-deferred retirement savings and Roth 401(k)s are, so it's also a smart spot to park your cash if you want to be able to withdraw the money at your own pace. RMDs can force some retirees to withdraw more money from their retirement accounts than they want to, and this can raise their tax bill. You won't have to worry about this quite as much if you stash some of your savings in an HSA.
Not everyone can contribute to one, though. You must have a high-deductible health insurance plan, which is defined as one with a deductible of at least $1,400 for an individual in 2020 and $2,800 for a family. Individuals may contribute up to $3,550 to an HSA in 2020 and families may contribute up to $7,100.
No matter your age or retirement goals, you will have to save a lot of money if you ever hope to leave the workforce. But there's a difference between just saving and saving smart. Use the above tips to ensure that your dollars stretch as far as possible in retirement.
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