How much is enough? Assuming you retire in your 60s, you’ll need to bank 25 times your final salary in order to have a 90 percent chance of having enough money to last the rest of your life. Don’t cry, just read this article. Trust us, 30 years from now, you’ll thank your lucky bank account.
Step 1: Find Out How Much to Save
Take your age and divide it by two. That’s the percentage of your income you should be putting toward a qualified retirement plan like a 401(k) or an IRA (for definitions, see the glossary). So, if you’re 20 years old, that’d be 10 percent; if you’re 36, that’d be 18 percent. This sliding scale works because the older you get, the fatter your salary (usually), and the more you should be able to set aside, says Robert Pagliarini, author of The Six-Day Financial Makeover.
If parting with this percentage of your paycheck sounds tough, don’t get discouraged. “The most important thing is that you just put away something,” says Jean Chatzky, author of Make Money, Not Excuses. Here’s how: Examine your budget and see the dollar amount you can put in. Figure out what percentage of your salary that is and opt to contribute that much. Sign up to have the money automatically withdrawn from your paycheck -- over time, you won’t miss it.
If every cent of each paycheck is spoken for, consider tinkering with your W-4 so that less tax is withheld from your take-home pay, recommends Sharon Epperson, author of The Big Payoff: 8 Steps Couples Can Take to Make the Most of Their Money and Live Richly Ever After. In 2006, tax-refund checks averaged $2,000, which amounts to $166 per month that could have been stored in a 401(k).
Step 2: Invest Right
True, stocks (also known as equities) can seem like a risky gamble, especially if you’re not a financial whiz, which may be why 19 percent of 401(k) owners in their 20s and 13 percent in their 30s aren’t invested in stocks at all, according to a 2006 survey by the Employee Benefit Research Institute. These people, however, are shortchanging themselves (out of hundreds of thousands of dollars) down the line. Stocks may zigzag on a daily basis, but over time, they go up. Case in point: The Dow Jones Industrial Average rose 605 percent between 1986 and 2006. That means, in 20 years time, a $1,000 investment ballooned into $605,000! Our point is that because you’re young and probably won’t be using this cash anytime soon, you can weather a fair amount of risk. How much? Some guidelines:
An ideal mix is 80 percent stocks and 20 percent bonds. Ideally, 40 percent of those investments should be large-cap stocks (established companies), 20 percent mid-cap (medium-sized companies); and 20 percent international. Monitor your funds on a quarterly basis and make sure to rebalance the mix so it stays at the 80/20 ratio.
Buy mutual funds, which are collections of various equities and are less risky than individual stocks. The top places to shop: Vanguard (known for its low fees), T. Rowe Price, Fidelity, and American Funds. If you or hubby enjoy the thrill of playing the stock market, do so with a small amount and consider it entertainment, like a trip to Vegas.
Keep it simple by consolidating 401(k) and IRA assets into as few accounts as possible. This should eliminate unnecessary account fees and provide you with a greater ability to manage them as an integrated portfolio, says Don Atherton, a Certified Employee Benefit Specialist and President of Integrated Benefits Solutions Inc.
Step 3: Max Out Your 401(k)
Given there are various places to stash your retirement cash, which should you pick? Your first priority should be to fill up your 401(k) to the point that you’re getting any company match -- otherwise it’s like saying “no thanks” to free money from your employer. Then, funnel the rest into a Roth IRA if you qualify (in 2007, your income must be less than $150,000 if you file jointly). Why? Because with the Roth, you won’t pay taxes on the money when you withdraw from the fund during retirement, which will offset the taxes you'll be paying when you pull from your 401(k). By contributing to both, they balance out.
If you and your mate both work and have employee-sponsored retirement plans, a little finessing on who contributes to what can work in your favor. If you’ve both got a 401(k), see who has the better company match, then try to contribute at least that amount to capture the match before allocating funds to the other account.
If only one of you works, this person can still contribute to the retirement pot via a Spousal IRA (see the glossary). As you get closer to retirement, your investments should become more conservative in order to protect yourself against market volatility. To build this safety measure directly into your investments, select lifecycle funds or target-date funds, which are a mix of investments that change over time and become more conservative as you approach a date of your choice.
Step 4: Factor in Kids
Once little tykes enter the picture, it can be tempting to think their needs (in particular, saving for college) trump your own. Not so fast. “There are loans available to pay for college. There are no loans to pay for your retirement,” points out Buckner. That said, if you’re maxing out your retirement plans, there are things you can and should do to ensure your children’s financial futures too.
To start saving for junior’s college tuition, invest $100-200 per month in a 529 plan. You can even open an account before your child is born; just use your own Social Security number when it asks for the beneficiary. Then when you get a Social Security number for your baby, switch the beneficiary information over to him or her. The limit is $12,000 per year, earnings and withdrawals are tax-free, and you can even use it yourself if you decide to go back to grad school. To leave your kids even more of a legacy, open an UGMA account (Uniform Gift to Minors). Every year, each spouse can give a child $12,000 without incurring a gift tax. We’re not saying your offspring will grub over who gets what when you pass away, but to ward off that remote possibility, hire an estate planner. You can find one at the National Association of Estate Planners and Councils at naepc.org or the American College of Trust and Estate Counsel at actec.org. For wills or estate software, go to nolo.com.
-- Judy Dutton
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