If you are like the average person in their 50s, you probably do not have too much saved for retirement. While the average recommended savings for retirement by age 50 is 6 to 8 times your annual income, the average retirement account by 50 is less than $120,000 according to Fidelity.
Why are Americans leaving themselves vulnerable by not prioritizing their retirement savings?
Between the expenses of rearing children and paying for college, buying homes and cars, and trying to live a somewhat normal life, for the average family, saving for retirement has not been made a priority. Even if you did have a few hundred dollars extra to save each month over the decades, many couples delay focusing on their retirement to “next month” or “next year” and never make the conscious effort to pay themselves first with each of their paychecks.
As we all know, time tends to accelerate as we get older, and by the time we realize we have a short runway until we reach retirement age, there is little time to bolster our savings rate.
For people who started investing at a young age, the vast majority of their retirement nest egg will be from capital gains and dividends and not from their own contributions thanks to the decades of compounding.
As an example, if a 25-year old saves and invests $6,000 per year until they reach 65, based on the historic market return of 10%, they will have nearly $2.7 million in their retirement account. However, over the 40 years of contributing to their retirement account, they only put in $240,000 of their own money. Since on average the balance will double every 7 to 8 years, over $2.4 million would be from capital gains and dividends that were reinvested along the way. For this reason, putting away as much as possible as early as possible will help secure your family’s future when you retire or are no longer able to work due to age.
Even if you have not diligently saved or have not been able to sock away extra retirement money each month, there is no time like today to start preparing for retirement or financial freedom in your 60s or 70s.
Here are a few helpful steps that you can take to alleviate some financial stresses as you enter your 60s, 70s, and 80s.
1. Pay off consumer debt
If you have any balances on student loans, car loans, medical debt, or credit cards, you should make a concerted effort to pay off these balances as soon as possible.
Since the interest on this debt can range anywhere from 5-30%, paying off this debt is a guaranteed rate of return that you may not necessarily get in the market in the short-term. Additionally, the last thing you want is to have lingering consumer debt follow you into retirement when your income will typically decrease, and you’ll still be stuck making payments out of a limited pool of money.
Even if you can afford the monthly payments now, a sudden job loss or other loss of income due to health reasons as you age can put you in a very vulnerable position and hamper your lifestyle in retirement or while trying to scratch together some savings to invest. If you are in your 50s, more than likely you are in your peak earning years – whether due to job promotions or even just cost of living adjustments that have compounded over the decades of working.
Unless you are in a marketable field where your experience is in high demand, a job loss at your current company could have you taking a few steps back on the pay scale as you try and regain your career footing. For this reason, you should strive to eliminate your consumer debt in preparation for a stress-free retirement.
Whether you apply the Dave Ramsey “snowball” approach where you pay your debt off smallest to largest regardless of interest rate or you pay off your high-interest credit cards or consumer loans first, eliminating debt service payments should be forefront in getting your financial situation in order prior to retirement.
By eliminating debt, you are guaranteeing yourself a rate of return at the interest rate on the loan. For this reason, a laser-like focus to pay off all debt greater than 4% before beginning to invest should be a serious consideration and step to implement if you want to be debt-free.
While the market has returned 10% on average, an element of inherent risk is involved to investing since there are no guaranteed returns and the market make decrease in any given year. Additionally, eliminating payments from your life will ease your financial stress and allow for room in your budget to begin piling money into investments to regain ground on your savings for retirement.
2. Start saving NOW
By the time you reach 50, the reality is you may only have 15 or 20 years to be fully invested in the stock market until you start needing to pull money from whatever nest egg you have assembled.
As you get older, most financial planners will recommend shifting away from a 100% allocation to the stock market and to diversify into a more conservative portfolio allocation as you near retirement age. If you were to have half your portfolio in more conservative investments, your portfolio would be generating a much lower overall return, and you would probably not have a nest egg that will last throughout the duration of your life.
The harsh reality is while investing 100% of your portfolio in the stock market can result in volatility, if you have nothing saved or very little saved for retirement, you are at an even greater risk of not having enough income to support you should you live well into your 80s or even 90s – an ever more likely outcome with advances in modern medicine.
For those that have saved and are in their 50s, moving a portion of your portfolio from aggressive-growth funds into more conservative investments such as dividend-oriented funds, a small allocation to balanced funds or bonds, and smaller percentage of growth funds can help your portfolio continue growing with less volatility.
However, if you are just starting to save, you will probably need to take on a little more risk by staying invested in aggressive growth funds and growth funds with less exposure to bonds through balanced funds. The difference in you and someone who has diligently saved over the course of their life is that you will more than likely have another decade or two to generate income through working compared to someone that fully retires in their early or late 60s.
In order to ensure you are able to survive into your 90s with a portfolio that produces supplemental income, you will probably need to plan on extending your career into your 70s and plan on maxing out every available retirement option available. The good news is that most people are at their peak earning years in their 50s. Additionally, by this age, you children should be grown adults with careers of their own and no longer need support. However, if your children are grown and working on their own and you are still supporting them, you must stop enabling them through you financial support – even though it is hard. Every parent wants to see their children live their best lives; however, all too often parents sacrifice their own future too deeply. Unless you want to be a financial burden to your children and their spouses and family when you are no longer able to work, you must begin getting your own financial house in order. Once you have built a substantial nest egg, you can begin laying down a plan to leave a legacy to your children and grandchildren after you are supported through the remainder of your life.
In addition to limiting financial support for grown adults, if you own a home, odds are that you are on the tail-end of the amortization schedule on your mortgage and it will be paid off in the next 10 years or so. Obviously, the lowered expenses will free up thousands of dollars that can be reallocated to investments.
How much can you invest?
For individuals under 50, the IRS limits contributions to employer-sponsored 401(k) plans to $19,000 and $6,000 for Individual Retirement Arrangements (IRAs) in 2019. However, if you are over 50, you are allowed to contribute an additional $6,000 to a 401(k) plan and an additional $1,000 to an IRA.
Therefore, a married couple over the age of 50 would be able to contribute $50,000 to their 401(k) plans and $14,000 into IRAs in 2019. If you were to invest this $64,000 amount each year for 20 years into the S&P 500 index fund that earns an average of 10% per year, you would have a portfolio of around $3.7 million by the time you are 70. By this age, you could shift into a less aggressive allocation that generates returns around 6%-8% with less volatility. At these returns, you should be able to safely withdraw around 4% of the portfolio each year and never touch principle. At this withdrawal rate, your portfolio would generate around $150,000 per year in income in perpetuity and would shield you from inflation over time.
Granted, in order to invest $64,000, you would probably need to be making a combined income of $175,000-$200,000 depending on your lifestyle and other expenses you may have now. However, even if you were only able to save half the amount discussed which is $32,000 per year, you would still have a portfolio that generates $75,000 each year to supplement any income you are receiving from social security or from working part-time.
What accounts should you open for your retirement investing?
As previously mentioned, you should be putting as much away as possible into retirement specific accounts. Whether you have a 401(k), 403(b), SEP IRA, Traditional or Roth IRA, there are several factors to consider when putting away money for retirement.
There are two primary types of accounts that differ based on how they are taxed: Traditional and Roth
Traditional 401(k) or IRA
With Traditional contributions, you receive a tax deduction on your current year tax return in the years that you make the contributions. However, when you are making withdrawals from these Traditional accounts in retirement, the withdrawals are treated as ordinary income and taxed accordingly.
In essence, by contributing to Traditional accounts, you are deferring any taxes you would have had to pay on your income until retirement when hopefully, your tax rates are lower (whether through withdrawing less than you earn today as your lifestyle decreases or through legislative changes that result in lower tax rates). As an added benefit, any gains and dividends in the accounts can accumulate and snowball into an even larger amount without the government taxing them along the way. However, you will eventually be forced to pay the taxes as you withdraw the money or through required minimum distributions at age 70 ½.
While the Traditional accounts may be a decent choice for high-income earners in the upper tax brackets if the tax savings are also invested, the Roth 401(k) or Roth IRA option is generally the best choice when putting away money for retirement.
With a Roth 401(k) or Roth IRA, you do not receive a tax deduction for your contributions. However, you never have to worry about paying taxes when you withdraw the money in retirement. Remember that $150,000 we discussed earlier if a married couple were to max out your retirement accounts? If you had chosen to invest in a Traditional account, this amount withdrawn would be taxed. A married couple would probably only actually bring home $110,000-$115,000 out of the $150,000 due to taxes. If you had chosen a Roth 401(k) and Roth IRA, there would be no taxes on the $150,000, and you would be free to spend the full amount in retirement. By contributing to a Roth, you may not get the tax deduction; however, since most of the portfolio will be comprised of capital gains and dividends, you will never have to worry about paying taxes. The net result is as if you had invested an extra 20-30% in your account depending upon your tax rate.
While we have just discussed why the Roth options are great choices, if you have a 401(k) or similar account with a match, this would be the first place to start even if you do not have a Roth option. Getting the employer match is “free money” that is also invested and will grow to make up a substantial sum over the ensuing decades. Therefore, the first place to start would be to fund your 401(k) or other employer-sponsored account to the point where you get the maximum amount you employer matches. If you do have the Roth option, this would be a double win and the route to pursue first.
After getting the maximum match in your respective employer-sponsored account, you should plan to open a Roth IRA. Even if you make over the IRS limit, you are allowed to open what is called a “Back Door Roth” where you open a Traditional, after-tax IRA and immediately convert the account to a Roth. You will not be allowed to deduct the contributions from your current taxes (hence, the “after-tax” connotatoin), but there is a legal loophole in the tax code that allows these to be converted to a Roth when “high-income earners” would not otherwise be allowed to open a Roth directly. Do a little research on your own or see a financial advisor for the full scoop and help pursuing this option.
After maxing out each IRA ($7,000 per IRA in 2019 since you are over 50), go back and fully fund each of your employer-sponsored account beyond the employer match (max of $25,000 in 2019).
Following this method will allow for the best use of your retirement accounts by obtaining the full matches and allow you to enjoy the full balance that will be accumulated over the next couple of decades.
3. Eliminate most of your housing cost before retirement
For most of us, our housing costs comprise the bulk of our monthly spending and budget. In the U.S., the average monthly mortgage payment is just over $1,000. With the median household income at around $60,000, housing expenses work out to around 20% of the average American household’s gross pay.
Even if you are not fortunate enough to live in an area where housing costs are only $1,000 per month and the income you earn in the higher-cost-of-living area does not make up for the expensive housing, your primary goal should be to payoff your home by the time your retire or plan to sell the home and downsize.
While 20% of gross pay is a reasonable amount to budget, in retirement, you will more than likely take a pay-cut which could result in housing costs making up a substantial portion of your overall spending. Coupled with higher healthcare costs and more time during the week to spend money on consumer goods or travel, servicing a mortgage payment could greatly hamper your desired lifestyle in retirement.
For this reason, if you are in your 50s, you should make a conscious effort to eliminate your housing expense prior to retiring if you do not have a very large account balance to support your desired lifestyle in retirement.
Since the largest “investment” that most people make is in their home, another option is to sell your home and downsize – especially if you needed a large home for all of your children but are looking to simplify your living situation. Because of the cost of maintaining a primary residence which can cost 1%-2% of the homes value per year, selling the home, paying off the mortgage and downsizing to a residence that better fits your current lifestyle with the equity in your old home could be a great option to consider.
For many middle-aged or older Americans, they enjoy the flexibility and hassle-free nature of renting once they no longer have children living at home that is zoned to a particular school district. While renting is generally cheaper than owning a home with a mortgage due to the principle and interest, property taxes, maintenance and repair, owning your own home outright would generally be better than renting for retirees.
Why is owning a home better for retirees?
Generally, owning a home is better than renting for retirees because of a few reasons.
Firstly, your mortgage payment is locked in for a specific period of time and does not increase year over year. Rent payments, by contrast, generally increase each and every year. If you have a relatively long retirement where you are a renter the rest of your life, more than likely, your rent will eventually double due to rent inflation while your income will still be fixed or decreasing in retirement. Eventually, you could be priced out of the rent market or be forced to downgrade in the quality of your residence.
Secondly, the primary redeeming factor that makes up for the increased expenses and hassle about owning a home is that eventually, your mortgage will be fully paid off. This means you will no longer have a housing payment. While owning a home is generally more expensive over the course of your life, the equation flips and you begin recouping the excess cost once you no longer have a housing payment and can re-allocate those dollars to investments and savings.
For this reason, individuals and couples in their 50s should make every effort to pay off their house as soon as possible but especially before they retire. By paying off their mortgage early, they will be able to allocate more money to their retirement accounts which will allow them to make up for lost time. Additionally, their fixed housing costs will be locked in at $0 in retirement. While there will be minimal maintenance costs, having a paid for house in retirement is still better than being exposed to ever increasing rent payments.
If you have not been able to begin putting back money for retirement before your 50s, now is the time to develop a game plan to secure your family’s financial future. Even if you believe you will work the rest of your life, you should still have a financial nest egg that gives you the option to wake up and go to work rather than being forced to work just to survive.
While staying active and productive in your older years can be admirable and worthwhile if you have a passion for your work, there are no guarantees that your health will allow you to continue working or that circumstances beyond your control could impact your quality of life. By having a few million dollars in the bank and investments, you will be able to make the choice every day of whether you want to continue working. If one day you wake up and no longer want to work, you could simply quit or change your job if you know longer enjoy what you do or do not like how you are treated. Having financial freedom would also allow you to start your own business or get involved with work in areas that you are passionate.
Obviously, the earlier you begin saving, the better off you will be financially later in life. Even if you have not saved a penny by 50, there is still time to get your house in order and prepare for life that does not require you to be a slave to your 9-5 job. However, you should not delay any longer and take these steps in order to put yourself on track to live a dignified life in retirement and leave a legacy for your family.