Saving for retirement involves several levels of financial planning. You need to get and stay out of medical, credit card and other types of debt. And you must resolve to invest a part of your income on a regular basis. If you save in the right places, you might get some help from your employer or qualify for tax breaks. You will also need some cash on hand to cope with emergencies without disrupting your savings plan. Here's how to get your financial priorities in order so you can accumulate a nest egg for retirement.
Deductibles covered. You need to have enough money saved to cover basic emergencies. Covering insurance deductibles should be the very lowest level of cash you keep on hand.
Match from your employer. Everyone who has access to a retirement plan that provides a match should work to take advantage of that free money. Many matching structures provide a 50 percent or even 100 percent rate of return on money you save in the account up to a certain percentage of your salary.
Eliminate credit card debt. The priority between an employer match and credit card debt is a coin toss. Consumer credit card debt and punitive interest rates charged should be avoided if you are going to be on the path to financial independence. Credit cards should be treated as a convenience with the understanding that accounts will be paid in full monthly. If you struggle with keeping credit cards paid off, you may need to enlist the help of a debt specialist.
Emergency reserves. You need to save three to six months of living expenses for a rainy day and the unexpected events that can make life scary. If you're trying to determine where you fall in the range between three to six months, do a quick career analysis to estimate how long it would take to find another job. If you carry lots of financial responsibility, such as having several people who rely on you financially, or have a volatile income, as many entrepreneurs and freelancers do, you might want to err on the side of caution and build a bigger emergency fund.
Roth contributions. The thought of tax-free growth is exciting. Imagine investing $10,000 in a S&P 500 index fund while you are in your 20s and then using that money in retirement after it has grown to over $60,000. That $50,000 of growth will be tax-free if you saved that money in a Roth IRA. You can save up to $5,500 per year in a Roth IRA if you are under 50. If you're 50 or older, you can save as much as $6,500.
Max out retirement accounts. Retirement accounts are great for building wealth for the future. 401(k)s and 403(b)s allow you to save $18,000 annually. It is not uncommon for employers to offer a traditional tax deductible account as well as the option to make after-tax Roth contributions that will be tax free in the future. However, outside of hardships, your access to this money could be limited prior to 59 1/2 years of age, and early withdrawals will trigger taxes and penalties.
Set an accumulation goal. With the loss of pensions, the majority of us will have to build and provide our own assets for financial independence. You should aspire to save 15 to 20 percent of your gross annual income. Retirement assets stashed in 401(k)s, 403(b)s and Roth IRAs will provide the foundation for that savings goal. Once retirement account opportunities are maxed out, consider opening an individual or joint investment account to complete your accumulation goal.
Debt prepayment. The desire to be master of your financial life includes being completely debt-free. There is nothing wrong with paying down debt early on mortgages and student loans if you are covering your other financial obligations. There is a tremendous psychological benefit when you don't owe money to anyone else.
Prioritizing these financial obligations requires you to sit down and organize your personal financial situation. That organizing process is the first step in building a long-term vision for your financial journey toward retirement.
The plan will also uncover if you have weaknesses in how you manage cash flow. No one expects that you will make it through the entire list of financial goals immediately, but it is fulfilling when you know that you have a plan to reach success.
Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".
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