When Should You Start Planning for Retirement?
The ideal answer to start planning for retirement from the day you get your first paycheck! When you’ve just left school, retirement sounds a long way off. It seems crazy to even consider planning for it. However, early planning might make the difference between retiring comfortably and having to find work as a retiree.
Why? Compound interest is why you should start contributing as early as possible. Here’s an example to demonstrate the power of compound interest:
Dave, in his 20s, contributes the maximum to his 401K for ten years and then stops. His best friend, Jeff, only starts contributing in his 30s but continues to pay monthly for the next three decades. Who do you think will retire more comfortably?
If you said Jeff, think again. Even with 30 years of contributions under his belt, Jeff can’t make up the difference. Dave ends up with about $400,000 more because of compound interest. He has earned interest on his capital and then interests on that interest.
Starting Early Is About More Than Compound Interest
Inflation eats away at the buying power of your money. You could put all your money in a bank savings account, but the performance levels are low. Your money faces little to no risk in a bank—and the low-interest rate reflects this.
For growth to outpace inflation effectively, investing some money on the stock exchange is usually necessary. The downside of investing in equities is that the market will fluctuate. Over ten years or more, however, the gains typically balance out the losses.
Still, experts recommend that you start looking into equities when you’re younger since you will have more time to absorb the risks of the market.
Retirement Planning Tips
You now understand why you should start planning for retirement early. Now, let’s look at specific retirement planning tips.
Understand the Timelines
In your 20s and 30s, you should keep the majority of your investments in stocks. With three or more decades until your retirement, you have plenty of time to balance out any dips in value from the fluctuating market. When you start getting closer to retirement, however, your risk appetite should decrease.
When you are ten years away from retirement, you should begin to focus on more secure investments. Bonds give you a guaranteed return and are not as volatile as stocks. Your goal now is less about beating inflation and more about providing a living income.
Why? You don’t want to risk the stock market being in a slump when you need to start drawing out your money.
Work Out How Much You’ll Need
When the time comes to begin to draw down from your retirement savings, how much should you withdraw at a time? Many retirement plans pay a defined benefit of 70% to 80% of your salary when you retire. You might assume that amount will be more than enough. However, you might be wrong, especially if you’re still paying a mortgage. Unexpected medical expenses and the rising cost of living can erode your savings quickly.
Another factor is that we are living longer than in earlier generations. You will, hopefully, live comfortably into your 90s. You don’t want to be in a position where you outlive your retirement income.
For these reasons, many retirement planners believe you should estimate a monthly retirement income figure that is 100% of your current earning ratio.
The Taxman Wants His Cut
Unfortunately, we don’t stop paying taxes when we retire. Be sure to factor in the taxes when planning for your retirement income, too.
How to Save Money and Get Out of Debt Before Retirement
What’s the number one retirement planning tip? Get out of debt as quickly as possible. Saving money towards your retirement is essential because of compound interest. You should pay down debt for the same reason.
Let’s take your mortgage as an example. For the first few years, you won’t see much of a drop in the balance. Why? You’re primarily paying off the interest.
If you withdraw any equity you’ve built, you are effectively making yourself pay off the interest on the whole amount again from scratch. The difference here is that whereas investment interest adds to your balance, mortgage interest adds to your liability.
Prioritize paying down your debt through smart expense management. Start by looking at your monthly bills to see where and how you might cut expenses. Shop around to get the best Dominion Energy rate, insurance rates, or mortgage financing. Could you pay less for cable or satellite services? For internet services? Look at your phone service provider’s plan options as well. Review all your essential expenses at least once a year.
In the meantime, work hard at improving your FICO (credit) score. Soon, you’ll be in an optimal position to negotiate a better deal on loans. Use any money that you save to pay down your debt. If necessary, get a second job to speed up the process.
Paying any extra funds possible into eliminating your debt means entering retirement with a clean slate. Aim to own your home outright, be debt-free, and begin your golden years with a strong financial foundation.