Planning for retirement is like running a marathon. You should set a steady pace and keep going. You don’t want to reach age 60 to discover that you can’t retire in five years because you didn’t save enough. Considering the financial challenges to Social Security and the demise of pensions, it is even more important today to start early on your retirement plan. The goal should be to become financially independent, allowing you to do the things you want without financial restraints.
Too many people go through life stumbling around financially hoping that one day they’ll win the lottery, but financial independence does not come by happenstance. Here are six things you can do this year to help move you closer to realizing your retirement goals.
Establish a budget, but recognize that this budget doesn’t tell you what you can and cannot spend money on—you make those decisions. The goal should be to spend less than you earn. Prioritize your savings so that you are saving something out of every paycheck. Developing this habit early on will help you reach financial independence sooner. A minimum savings of 10% each pay is a good place to start. Then increase the percentage every year if you can. Payroll deduction and automatic savings plans are an easy way to stick to your savings discipline because the money is put away before it can get spent on anything else.
Financial advisers say that you should always “pay yourself first,” which places a priority on savings. I think the importance of this principle is deeper than just accumulating savings. It is about controlling your spending. It doesn’t matter how much money you have; if you can’t control your spending, you will never be financially independent. During fiscal year 2019, the federal government collected approximately $3.46 trillion in tax revenue but spent $4.45 trillion. In my opinion our government doesn’t have an income problem, it has a spending problem.
Start early and save regularly
You start off life working for money, but ultimately, you want your money to work tirelessly for you. When you save early and regularly, the potential earnings on your investments—and the annual compounding of those earnings—can make a big difference in your final return and the timing of your financial independence.
According to Motley Fool, a person who starts saving $400 per month at age 25 will have $1 million at age 65. If you wait until age 30 to start saving, you would need to save $580 per month to have $1 million at age 651. Procrastinating until age 40 will require a monthly savings of $1,275 per month. This illustrates how important time is to the success of your financial future.
Track your Social Security benefits
People barely take notice of Social Security until it’s time to draw benefits. The Social Security administration produces an annual statement for everyone who has paid into the system and is not drawing benefits. However, you must log into SSA.gov to get it. Check your statement annually to make sure your earnings are being recorded correctly. The monthly benefit at retirement is based on your earnings history. It is much easier to get this fixed if you do it right away. You will be required to show proof of earnings and Social Security taxes paid. Most people can produce this easily for the last couple years, but going back 10 years can be a lot harder.
Maximize your retirement benefits through your employer
Many employers will match a percentage of the contributions their employees put into the company retirement plan. Contribute at least as much as the employer will match. If your employer matches a certain percentage dollar for dollar, that’s a 100% return on your investment from day one. On top of the employer match, you get tax benefits to boot.
Contribute to a Roth IRA
Ideally, all your retirement savings should not be in a tax-deferred account when you become financially independent. Some of your savings should be accumulated in a Roth IRA where the withdrawals will be tax-free. You can contribute up to $6,000 in 2019 if you have at least that much in earned income ($7,000 if you are age 50 or older). If your income is too high to make a Roth contribution directly, make a non-deductible IRA contribution and then convert it to a Roth2.
Avoid using the money you have accumulated
Don’t invade the money you have accumulated for financial independence for any other reason. To do so will cause a significant setback to the timing of achieving your goal. Money spent can no longer grow and compound and serve us. Assuming an 8% rate of return, $10,000 spent today could have grown to $110,000 in 30 years. Using the 4% rule, that money would provide $4,400 per year of income for your financial independence.
- Always spend from your income within your budget and avoid touching your long-term savings.
- How much you spend is just as important as how much you make. It is unlikely you will ever be able to earn enough to become financially independent if you can’t control your spending.
- Fund a Roth IRA every year you can to assure there is a source of tax-free income when you are financially independent.
1 Want to Be a Millionaire by Retirement? Here’s How Much You’ll Need to Save Each Month, by Katie Brockman. Motley Fool. June 8, 2018.
2 See Converting an IRA to a Roth IRA? Know the Pro-Rata Rule, May 31, 2018, for rules on converting non-deductible IRAs to Roth IRAs.