Rules of thumb are often intentionally vague so that each person can apply them to their own individual situation. We all know it’s important to save for retirement, but each person will have different savings goals. Some of us want to travel the world in retirement—others just want a simple living with their own half-acre for grandkids to play on. No matter your goal, consider these five retirement rules of thumb that can provide guidelines for an effective retirement plan.
If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.
Start Saving As Early As Possible
When it comes to saving for retirement, starting early gives you a bigger leg up on your peers than an outsized investment return. Time horizons are a crucial factor in any retirement plan, but those who start early are able to accept more risk since their time horizon is long and they can wait out a market recovery.
If you begin saving for retirement too late, you’ll need to face an uneasy decision: do you take on more risk in order to increase the chances of reaching your goals? Or can you cut your lifestyle back in such a way that it allows you to save more? Live frugally, or take on more market risk? If you start investing for retirement early, this is a situation you can avoid.
Fees Matter More Than Returns
This particular rule of thumb won’t always be true, but for most buy-and-hold retirement savers, fees are of greater concern than overall market returns. Why? Because of control. Market returns are outside of our control. Sure, on average you’ll get between 6-10% per year (depending on your data source) by investing in the stock market, but you have no say in what the final tally will be.
However, expensive mutual funds and ETFs can severely cut into your nest egg over time. Remember, compound interest works both ways. Index funds with low expense ratios are usually a good option for retirement savers rather than high-priced, actively managed ones that buy and sell shares looking for outsized gains.
Always Consider Your Tax Obligations
When we do eventually cash out our investments for retirement spending, the IRS unfortunately is going to get involved. How much you’ll owe in taxes varies greatly depending on which vehicles you used for retirement saving and how much your income is.
For example, if you have a Roth IRA, your tax obligations have already been met. Investments grow tax-free in a Roth and you can tap the money after age 59.5. But if you have a 401(k), you’ll owe taxes when you start taking distributions. If you want to work part-time after retirement, forgoing the 401(k) distributions and taking funds from a Roth will lower your tax burden. Once you’re 100% retired, you can tap the 401(k) and expect to pay less in taxes now that you have no income from employment.
Any investments held longer than a year will be taxed at the capital gains rate, which is more advantageous than the income rate for investment held less than one year. Always consider long-term vs short-term tax obligations when selling investments in a non-tax sheltered account.
Save 10% of Your Income (If You Can)
Rules of thumb like this can be controversial since not everyone can afford to sock away 10% of their annual income, but it’s important to set the bar somewhere. If you can afford to save 15% of your income, you should do that. If you can only afford to put away 7% of your income per year, that’s okay too. The goal should be a fixed percentage per year so that if your salary goes up, so too does the amount you’re saving each year.
Saving a fixed percentage of your income each year will not only create good habits, but also establish a baseline which you can then raise as you earn more (or spend less if you become an expert budgeter). It doesn’t need to be 10% or 15% right away—just set a goal and stick to it. Plus, a fixed percentage will help automate your savings so you don’t need to recalculate every time you get a wage bump.
Don’t Panic If You Start Late
If you haven’t started saving for retirement, don’t resign yourself to a life of work into your golden years. Simply start saving for retirement now. Don’t be discouraged if you’re behind on your goals—talk to an advisor and formulate a plan to make retirement saving work for you. After all, a small nest egg is more beneficial than no nest egg.
Work With an Experienced Financial Advisor
We hope these five retirement rules of thumb assist you. If you have any questions or need help creating a retirement plan, don’t hesitate to reach out to a team member from Good Life Financial Advisors of Mount Pleasant today.