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Retirement saving is a long-term plan to set aside and invest money to provide income after you stop working. It often involves contributing to accounts like 401(k)s or IRAs. Starting early helps savings grow through compound interest. Understanding these five basics could help you make decisions to support your financial goals. A financial advisor can also work with you to create a retirement plan.
Determining how much to save for retirement is where planning for your financial future begins. The amount you need to save depends on several factors, including your desired lifestyle, expected retirement age and life expectancy. Many financial experts recommend setting a goal to replace about 70% to 80% of the income you earn just before you retire to maintain your accustomed standard of living. This percentage can vary based on personal circumstances, such as healthcare needs and travel plans, so savings goals are tailored to individual situations.
A good place to start is by estimating annual expenses in retirement. Consider costs such as housing, healthcare, food and leisure activities. Once you have a rough estimate, multiply this figure by the number of years you expect to be retired. This will give you a ballpark figure for your total retirement savings goal.
Don’t forget to account for inflation, which erodes purchasing power over time. Using a retirement calculator can help you adjust for these variables and provide a more accurate savings target.
Each type of retirement account offers specific benefits and potential drawbacks. Choosing the right one depends on your financial goals and circumstances. Here are four common types and their key characteristics:
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Traditional IRA: Contributions to a traditional IRA are usually tax-deductible, which can lower your taxable income for the year. The funds in the account grow tax-deferred, meaning you won’t pay taxes on the earnings until you withdraw them during retirement.
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Roth IRA: Contributions to a Roth IRA are made with after-tax dollars so they are not tax-deductible. However, they have another significant benefit, namely, that qualified withdrawals during retirement are tax-free. Having retirement savings in a Roth IRA can be particularly advantageous if you expect to be in a higher tax bracket in retirement.
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401(k) Plans: These plans are sponsored by employers and allow employees to contribute a portion of their salary pre-tax, reducing taxable income. Many employers also offer matching contributions to 401(k) plan participants, effectively providing free money to boost your retirement savings.
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SEP and SIMPLE IRAs: Self-employed individuals and small business owners can use SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs to accumulate retirement savings. SEP IRAs allow employers to make tax-deductible contributions on behalf of their employees, with higher contribution limits than traditional IRAs.
There are many common investment options for retirement savers. However, each investment carries specific benefits and risks. Here are four common types of retirement investments to consider:
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Stocks: When you buy stocks, you become a part owner of the company issuing the shares. Stocks, also known as equities, offer the potential for significant growth over time.
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Bonds: When you purchase a bond, you are essentially lending money to a government or corporation in exchange for periodic interest payments and the return of the bond’s face value at maturity. Bonds are often considered a more stable investment when compared with stocks, since there is less of a chance for significant losses or gains.
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Mutual funds: Mutual funds pool money from multiple investors to purchase a diversified portfolio of stocks, bonds or other securities. This diversification can help reduce risk, as the performance of the fund is not tied to a single investment.
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Real estate: Investing in real estate can involve purchasing property to generate rental income or to sell at a profit. Real estate can be a valuable addition to a retirement portfolio.
When planning for retirement, ensure that your investment portfolio aligns with your long-term financial goals. A well-structured portfolio not only helps you accumulate wealth over time but also provides the stability needed to enjoy your retirement years comfortably.
To achieve this, consider your risk tolerance, time horizon and the lifestyle you envision for your retirement. Risk tolerance is your ability and willingness to endure market fluctuations. If you have a high-risk tolerance, you might be comfortable with a portfolio that includes a larger proportion of stocks, which can offer higher returns but also come with greater volatility. On the other hand, if you prefer a more conservative approach, you might opt for bonds or other fixed-income investments that provide steadier, albeit lower, returns.
Your time horizon, or the number of years until you plan to retire, significantly influences your investment strategy. If you have several decades before retirement, you might have the flexibility to invest more aggressively, as you have time to recover from potential market dips. However, as you approach retirement age, it becomes prudent to gradually shift towards more conservative investments to protect your accumulated wealth.
Investment fees are often overlooked but can significantly erode your investment returns over time. Whether you’re investing in mutual funds, exchange-traded funds (ETFs) or other financial products, each comes with its own set of fees. These can include management fees, administrative fees and sometimes even performance fees.
Management fees, also known as expense ratios, are paid to fund managers for overseeing the portfolio. These fees are typically expressed as a percentage of assets under management and can range from 0.1% to over 2%. Additionally, some funds may charge a front-end load fee, which is a commission paid when you purchase the investment, or a back-end load fee, which is charged when you sell.
Saving for retirement is a common strategy to help you build a secure financial future. This will require you to create a plan and adjust it as your circumstances evolve. Common steps to take include determining how much you need to save, choosing retirement accounts, selecting investments, aligning your portfolio with short-term needs and long-term goals, and managing fees.
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A financial advisor can help you create and manage a retirement plan for your specific needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you want to know how much you could earn from Social Security, SmartAsset’s benefits calculator can help you get an estimate..
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