In the 20th century, the American retirement system was supported by three financial legs: employer pensions, Social Security, and an employee’s personal savings. Essentially, employees shared the responsibility of saving for retirement with their employers and the federal government.
Life is different in the 21st century. Now employer pensions are all but history, and there is constant concern for the viability of Social Security. Employees are now principally responsible for saving for their own retirement.
Fortunately, employees today tend to have broad access to retirement accounts such as 401(k) accounts, Individual Retirement Accounts (IRAs), and Roth accounts. These accounts provide substantial incentives and benefits for retirement savings. Even with these tools, retirement saving is a lifetime endeavor that requires constant diligence and perseverance.
The Early Years
Retirement savings is most effective at early ages. Because of the miracle of compound growth, employees’ retirement savings during their 20s and early 30s is the most valuable savings they will ever have the option of obtaining. Suppose someone invests $1,000 when he or she is 25 and allows the savings to grow at the moderate rate of 6% annually. By the time he or she is 65 that initial investment will have grown to more than $10,000. Money saved in a qualified retirement plan like a 401(k) or a Roth IRA can grow unimpeded by taxes. The multiplying effect of early savings is tremendous and lays the foundation for successful retirement.
Into the 30s and 40s
Employees in their later 30s and 40s must stay the course of retirement saving, though they may face new headwinds. As people get married, have children, and purchase homes, their retirement accounts often appear to be convenient sources of cash to meet growing financial pressures.
Employees should resist the temptation to tap into their retirement accounts early. Any money taken out of a 401(k) or IRA will be fully taxable when withdrawn, lowering the actual value of the funds coming out.
Although there are some exceptions for first-time home purchases and medical expenses, cracking into a retirement account early will generally result in an additional 10% tax penalty. Any money taken out to meet an expense now will not be available during retirement.
The Finish Line
Employees in their 50s and 60s can see the finish line. Now may be the time to rebalance retirement assets to something more conservative, like a bond-heavy portfolio that will provide income and stability. Employees 50 and over have the option to make larger contributions to their retirement accounts through special “catch up” rules. Employees should consider taking advantage of these catch up contributions, even if they feel they are already caught up and ready for retirement.
Employees 60 and over can now take distributions from retirement accounts without incurring a 10% tax penalty. However, it may still be in an employee’s best interest to let the assets continue to grow in tax-preferred retirement accounts. Employees in their mid-sixties should consider taking Social Security retirement benefits and coordinate those benefits with distributions from other retirement saving accounts.
People in their 70s should simply enjoy retirement. With sufficient savings throughout a working life, people aged 70 ½ and older can expect required minimum distributions to provide for at least part of their lifetime income in retirement. Retirees should also consult regularly with a financial planner to make sure they are on course for a successful retirement.
Saving for retirement is a lifetime project. Although it may seem like a daunting task now, with a little forethought and some good advice, the right retirement savings can help make a person’s retirement years truly golden.