Do you want to save more this year? If so, you're not alone. Fifty-five percent of Americans listed “saving more money” as their top financial resolution for 2015, versus 20% who were looking to pay down debt, according to Fidelity’s Financial Resolutions Study.
So, are you saving enough—and saving smart enough?
In general, Fidelity believes that to reach your long-term retirement savings goals, you will likely need to save at least 15% of your earnings each year.1 That isn't easy, given rising prices for health care, education, and the general cost of living—and it’s all the more reason to maximize the tax advantages available to help Americans save.
We suggest setting aside three to six months of expenses in an emergency fund. But after that, we believe saving for retirement should be most Americans’ top priority. After all, you can probably get loans to pay for children’s education, or for a house, a car, or for other financial goals. But beyond your Social Security retirement benefit, you’ll likely need to fund your own retirement paycheck.
Here are eight tips, not necessarily in order, to help you save more and smarter this year. Depending on your situation, you might consider some or all of these.
Take full advantage of any company match.
If you have a 401(k), 403(b), or governmental 457(b) plan and your employer offers a matching retirement contribution, take full advantage of it. In addition to receiving the company match, you get the added potential benefits of any tax-deferred growth and compounding returns.
Let's say, hypothetically, your company offers a match of 50¢ on every $1 you contribute, up to 3% of your salary. If you make $60,000 a year and contribute 3%, or $1,800, and your company kicks in another $900, your annual contribution could add up to $2,700. Assuming a hypothetical compound annual growth rate of 7%, your savings could grow to more than $37,000 in ten years.2
Contribute the maximum to your workplace savings plan.
Saving just 3% a year is probably not enough to generate the savings you will need to retire, which could be hundreds of thousands of dollars or more for even basic expenses. So, try to contribute the maximum to your workplace savings plan each year. For 2015, the maximum is $18,000; $24,000 if you are age 50 or older. If you’re not quite saving to the max yet, consider increasing your savings rate by 1% per year until you reach a total savings rate of 15%. For details, read Viewpoints: “Just 1% more can make a big difference.”)
If you think your tax rate will be higher in retirement, consider opting for a Roth workplace savings plan, if your employer offers one. With a Roth, you contribute after-tax dollars, but any earnings and dividends grow tax free, and withdrawals are also tax free if taken in retirement. To learn more, read Viewpoints: “Roth or traditional IRA or 401(k)—two tips for choosing.” Also, new legislation has made in-plan Roth conversions easier.
Pay down high-interest debt.
If you are paying more than 8% to 10% on credit card or other debt, consider using any extra savings to pay down the balance. If you have multiple accounts, you should work on the one with the highest interest rate first. Continue to make the minimum required payments on other debts (so you don't get hit with any penalties). When that first debt is paid off, consider putting your extra money toward paying off the one with the next-highest interest rate, and so on.
As you pay off your debts, it should become easier to pay off the remaining debts, because you’ll have lower interest payments and therefore more money to work with. Continue the process until you're out from under all your high-interest debt. For debt you cannot pay off, consider consolidating it into a low-interest single credit card or home equity loan at whichever institution offers you the lowest rate, making sure the payment schedule matches your own goals and financial situation.
Contribute to an IRA.
Individual retirement accounts (IRAs) offer another tax-smart way to save for retirement. There are two basic options:
- Traditional IRAs, through which you can get a tax deduction up front if you meet certain income eligibility requirements. Any earnings grow tax deferred, but you pay income taxes on withdrawals. In 2015, full deductibility begins to phase out at annual adjusted gross incomes (AGIs) of $61,000 for singles and $98,000 for married couples filing jointly. The maximum contribution is $5,500 per person ($6,500 if you are age 50 or older) or 100% of employment compensation, whichever is less.
- Roth IRAs, through which you can contribute after-tax dollars if you meet certain income eligibility requirements. Any earnings grow tax free, and qualified withdrawals are tax free. In 2015, the maximum contribution for Roths is the same as for traditional IRAs. But there are income requirements: Eligibility begins to phase out at annual AGIs of $116,000 for singles and $183,000 for married couples filing jointly.
In general, if you think your income tax rate will be higher in retirement, you may want to consider opting for a Roth IRA. To learn more about Roth IRAs, read Viewpoints: “Nine compelling reasons to consider a Roth IRA.” To determine whether a Roth is right for you, use our calculator.
Consider a health savings account.
If your employer offers a high-deductible health care plan (HDHP) with a health savings account (HSA), you may want to consider electing the HDHP and opening an HSA. Our research shows that it can be a tax-efficient way to save and pay for current and future qualified medical expenses, including those in retirement. Although your out-of-pocket health care costs may be higher depending on your health care needs, your premiums may be lower. Also, many companies contribute to an employee’s HSA, and employee contributions are made pretax, which means your net after-tax costs can be lower. Contributions can also be made on an after tax basis. And what you don’t spend in your HSA in one year can be carried over from year to year to cover future qualified medical expenses, including those in retirement.
HSAs have a unique triple tax advantage3 that can make them a powerful savings vehicle for qualified medical expenses in current and future years: Contributions, earnings, and withdrawals are tax free for federal tax purposes To make the most of your HSA (if you have access to one and you can afford it), consider paying for current-year qualified medical expenses out of pocket and letting your HSA contributions remain invested in your HSA to pay for future qualified medical expenses, including those in retirement.
The maximum annual contribution that can be made for 2015 is $3,350 for individuals enrolled in self-only coverage and $6,650 for individuals enrolled in family coverage. In addition, individuals who are at least 55 years old, are not enrolled in Medicare, and who otherwise are eligible individuals can make an additional catch-up contribution. The maximum catch-up contribution amount is $1,000. To learn more, read Viewpoints: “Three healthy habits for health savings accounts.”
Consider deferring compensation.
If your company offers a nonqualified deferred compensation plan—and you have maxed out on other workplace savings options and still have the means—consider allocating some of your paycheck there as well. You can decide how much to defer each year from your salary, bonuses, or other forms of compensation. Deferring this income provides two tax advantages: You don't pay income tax on that portion of your compensation in the year you defer it (you pay only Social Security and Medicare taxes), and you can invest the money, so it has the potential to grow tax deferred until you receive it. But a deferred compensation plan is not for everyone—and the rules are complex—so you'll want to weigh the pros and cons carefully before signing up. To learn more, read Viewpoints: “Nonqualified deferred compensation plans.”
Consider deferred variable annuities.
If you’ve taken advantage of your tax-advantaged workplace savings options and contributed to an IRA but still want to save more, you might want to consider deferred variable annuities. They typically allow you to invest in funds that hold stocks and bonds—and any earnings grow tax deferred. Unlike some of the options mentioned above, there are no IRS limits on how much you can invest in an annuity.
- To maximize your savings potential in an annuity, it is important to choose one that is low cost, as investments in annuities are subject to insurance charges in addition to fund charges. When you’re ready to withdraw from an annuity, any earnings (in addition to any pretax contributions) are taxed at ordinary income tax rates (plus any Medicare surtax, state, and local taxes). Also, keep in mind that any taxable amounts withdrawn before age 59½ may be subject to a 10% IRS penalty. To learn more, read Viewpoints: “Create future retirement income” and “A shopper’s guide to annuity fees.”
Remember other savings goals.
It’s also important not to overlook saving for your other goals, such as college and graduate school for yourself, children, or grandchildren. Among the best ways to save for a college goal is a 529 college savings account, which is a tax-advantaged account designed to pay for qualified higher education expenses, and a Coverdell education savings account. For both types of accounts, qualified distributions are federal income tax free. To learn more, read Viewpoints: “The ABC's of 529 college savings plans.” To explore saving for an education goal, use our college saving tool.
One last tip: To make it easier to stay on track with your savings goals, consider using direct deposit from your paycheck to your chosen savings vehicles, be they workplace savings plans, HSAs, IRAs, annuities, or even taxable accounts. Then give yourself a pat on the back—you’re a smart saver.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917