Everyone dreams of the day when they can finally sell their business or leave the office and never look back. That’s called retirement.
A 2019 survey from Northwestern Mutual shows that 15% of Americans have no retirement savings and 20% of Americans don’t have $5000 saved or invested for retirement.
It’s important to start saving (and investing) for retirement so you can retire at age 65, or earlier!
Note that the “interest rate” on step three of the model below is actually the “rate of return” since this is investing rather than saving.
How Much Do I Save/Invest for Retirement?
While there is no clear cut number for retirement savings, saving 15 to 20 percent of your pre-tax annual income is a good rule of thumb. For example, if you make $50,000 a year, 15 percent would be $7500.
When planning for retirement you should take into account any debt you may still owe and the lifestyle you want to have or continue to have.
Retirement Savings/Investment Return
If you began with $1000, contributed $625 each month ($7500 a year) from age 30 to 65 and earned 8% return on the balance each year…
You would have $1.3 million to spend during retirement, having contributed just $260,000 — a gain of more than $1 million!
Types of Retirement Accounts
There are certain accounts that are designed to help save for retirement. They are called an IRA (Individual Retirement Account) and 401k. Both of these accounts allow you to invest in the stock market to maximize your investment earning potential! It’s important to note that retirement accounts do have restrictions on when you can begin to withdraw your money, typically around 60 years old.
Traditional IRAs allow you to contribute money that is tax-deferred until you start drawing it during retirement. Retirees typically fall in lower tax brackets because they’re not working a job. Therefore, the taxes on the Traditional IRA money will most likely be lower.
Roth IRAs allow you to contribute after-tax money. Since the taxes have already been paid on the money, it can potentially grow tax-free! This means that whenever you draw money from the account, you don’t have to pay taxes. Even teenagers can contribute to their own Roth IRA!
IRAs do have contribution limits, meaning your contributions are capped at a certain amount that varies each year.
A 401k is similar to a IRA in that you can contribute your own money towards your retirement.
However, with a 401k, your employer can also contribute to your retirement savings, provided that benefit is offered.
If you’re self employed or run your own business, you can still have a self-directed 401k!
Similar to traditional IRAs, money in a 401k account is taxed during retirement.
Like IRAs, contributions to 401k accounts do have contribution limits, although they are typically much higher.