Retirees in America are living longer than ever before, thanks in part to advances in medical care. According to the Social Security Administration1, a man who reaches age 65 today will live, on average, until age 84. A 65-year-old woman will live to an average age of 86. One out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95.
While longer, healthier lives are a welcome development, they also present new retirement planning challenges. A longer life expectancy means you will have to accrue enough savings during your working years to cover your living expenses in retirement for 20 years or perhaps much longer, depending on when you retire and how long you live.
Fortunately, there are many opportunities to contribute to a retirement savings account. If your employer offers a workplace savings plan, that is the first place to start. But many Americans are unaware that they can contribute to both a workplace savings plan and an IRA. Therefore, if you have not contributed to an IRA before, now may be the time to consider doing so.
The one-two punch of a workplace savings plan and an IRA will allow you to sock away more money for retirement. Add the benefits of an automatic savings plan, and you may be well on your way to accumulating the savings you will need to cover your expenses during your retirement years. Here are three simple ways to help you rev up your retirement savings strategy:
1. Start with your workplace savings plan
If your employer offers a 401(k), 403(b) or 457 plan, contribute the maximum amount that you can afford. The current annual contribution limit is $18,000 (plus an additional $6,000 catch-up contribution for anyone who is age 50 or over). Because you don’t have to pay taxes on the earnings generated by investments held in your workplace savings plan until you start taking distributions, your contributions will benefit from tax-deferred compounded growth.
If your employer matches employee contributions, be sure to contribute enough to earn your employer’s full match. That’s like earning an automatic 100% return on your contributions in year one. Even if you cannot afford to contribute the maximum amount each year, remember that any contribution to your retirement savings plan gets you closer to your long-term goals.
If you are not already participating in your workplace savings plan, open enrollment season usually occurs in the fall of each year, so be sure to check with your human resources department.
2. Add an Individual Retirement Account (IRA)
If you are contributing the maximum amount to your workplace savings plan, you may also want to consider establishing an IRA to supplement your retirement savings. Contrary to what many people assume, there is no rule against saving in both a workplace savings plan and a Traditional IRA.
Assuming you have earned income, you can contribute up to the maximum allowed in an IRA each tax year. If you are 50 or older, or will turn 50 before year-end, you can make an additional catch-up contribution.
There are two types of IRAs, Traditional IRAs and Roth IRAs. (Note that there is also a Rollover IRA, which is simply a Traditional IRA often used for rollovers from an old workplace plan, such as a 401(k).) Contributions to a Traditional IRA are made with after tax dollars and may be tax deductible if your income limit allows. These contributions grow tax-deferred and anyone with earned income (as well as their spouse) can contribute to a Traditional IRA.2 Contributions may be tax deductible, depending on your annual income and whether you already participate in a workplace savings plan.
With a Roth IRA, contributions are always made on an after-tax basis, so they are never tax deductible. However, your investments grow tax-free, which means you will owe no federal income tax on your contributions or earnings when you start taking distributions. This assumes you are older than 59 ½ and hold your contributions within the Roth IRA for a minimum of five years, beginning with the first taxable year after you contributed. 3 Keep in mind that if your annual income exceeds certain levels, you may not be eligible to contribute to a Roth IRA.
When you reach age 70½, you will need to begin taking minimum required distributions from a Traditional IRA. The amounts will be based on your life expectancy and you will have to pay federal income taxes on those distributions. With a Roth IRA, there are no minimum required distributions, which means your investments can continue to grow tax-free for as long as you like. If you do decide to take distributions, you will not have to pay any federal income taxes on that income. With a Roth IRA, you can also take distributions on the amount you contributed (but not earnings) before age 59½ with no penalty, as long as the five-year holding period is satisfied. Additional exceptions to the rules that govern early withdrawals include death, disability, or distributions for qualified first-time home buyer expenses.
Married couples have an additional opportunity to supplement their retirement savings by contributing to a Spousal IRA (Traditional or Roth). This allows spouses who do not work outside the home to also save in an IRA, subject to the same contribution limits.
3. Set up an automatic investment plan
Even if you can comfortably afford to contribute to an IRA, you may not relish the idea of writing a large check each year before the annual tax-filing deadline. As an alternative, you may want to consider establishing automatic monthly or quarterly contributions. Automatic contributions to your IRA take the decision making for retirement plan contributions out of your hands and help ensure you “pay yourself first.”
You can have funds transferred on a regular schedule from virtually any checking, savings or money market account at a bank, savings and loan, credit union, or brokerage account. While it’s generally a good idea to contribute the maximum amount possible to your IRA, any amount invested will help supplement your retirement savings. If you cannot commit to contributing the maximum monthly or quarterly amount, start with a lower contribution and gradually increase that amount until you reach the annual contribution limit.
An automatic contribution also helps ensure your savings will have more time to potentially grow. For example, if you begin contributing $400 a month to an IRA in May of each year and contribute that same amount for the next 11 months, your contributions will begin to compound earlier than those made right at the tax filing deadline.4
By investing a regular amount each month or quarter, you will also be taking advantage of an investment methodology known as dollar cost averaging. This allows you to spread your purchases over time and lessens the risk of investing a large amount in a single investment at the wrong time. You will buy more shares of an investment when its price is down and fewer shares when the price is up. While there is no guarantee that you will have a gain when you sell, dollar cost averaging may help reduce investment risk and build investing discipline.