It’s one of the most common financial questions asked by many people today: What is the best way to save for retirement?
There’s no one-size-fits-all answer to this question — because every retirement saver’s circumstances are a little bit different.
However, almost everyone can follow a handful of general guidelines. Here are seven tips on how to save money for retirement.
1. Get started saving as soon as you can.
This might be the most important retirement saving strategy of all because time is one of the biggest factors working in favor of retirement savers. To understand why, you need to understand the concept of compounding returns.
With compounding returns, the earnings on your assets are reinvested to generate even more earnings. For example, an initial investment of $1,000 earning a 9% return will earn $90 and be worth $1,090 after one year. This becomes the principal for the second year when the investment earns $98 and is worth $1,188. The impact of compounding really starts to accumulate over time: The investment will be worth $2,367 after 10 years, $5,604 after 20 years and $31,409 after 40 years.
The fact is, you can never recapture the power of compounding that is lost during years when you weren’t saving for retirement. This is why getting an early start on retirement saving is so important. It doesn’t matter how much you save, especially if you’re young and just getting started. The important thing is to save something for retirement each pay period.
2. Choose the right type of retirement savings account.
You have several different types of tax-advantaged retirement savings accounts to choose from, including the following:
Individual Retirement Account (IRA)
You can contribute up to $6,000 in 2021 to a traditional or Roth IRA, or $7,000 if you’re 50 or older. Depending on how much money you earn, you might be able to deduct your IRA contributions when filing your federal income tax return, which could lower your current income taxes.
This type of plan is provided through the workplace, with many employers offering to match a percentage of employees’ plan contributions (such as matching 50 cents for every dollar contributed by employees). You can contribute up to $19,500 in 2021 to an employer-sponsored 401k plan, or $26,000 if you’re age 50 or older. Your 401k contribution reduces your taxable income, which in turn may reduce your current income taxes.
Simplified Employee Pension plan (SEP)
This plan is designed to help self-employed individuals save money for retirement. The annual contribution limits are much higher than the limits for IRAs and 401ks: You can contribute up to $57,000 or 25% of your net earnings in 2020 to a SEP.
Read More: What is a SEP IRA and How Does it Work?
3. Take advantage of employer matching contributions.
These might be the closest thing there is to a “free lunch” because employer matches to 401k contributions represent a guaranteed, no-risk return. So if your employer matches your 401k contributions at 50%, that’s the same thing as a guaranteed, risk-free 50% return.
Many employers require employees to contribute a minimum amount to their 401k to be eligible for a match. If possible, you should contribute at least this much to your 401k each pay period.
4. Set aggressive but realistic retirement savings goals.
Goals provide a measuring stick for gauging your progress toward achieving a financially comfortable retirement. Start with a goal for how much you’ll contribute toward retirement each month or pay period. Over time, strive to increase this amount, especially as your income grows. Then set goals for how much you’ll accumulate in retirement savings by certain age milestones, such as 30, 40, 50, 60, and your planned retirement date.
Read More: The Average 401k Balance by Age
Your retirement savings goals should be aggressive but also attainable. For example, many people set a goal of saving 10% of their gross income for retirement. If this isn’t realistic for you, start out lower and work your way up so you don’t become too discouraged.
5. Automate your retirement savings.
With so many other financial priorities, saving for retirement can sometimes get pushed to the back burner. Automating contributions is the best way to make sure that your retirement savings come first, not last after all your other financial responsibilities are taken care of.
Most 401k plans take care of this by deducting 401k contributions from gross wages and automatically transferring the funds into participants’ accounts. If you have opened an IRA, you can accomplish the same thing by arranging for contributions to be automatically transferred from your checking account to your IRA each month or pay period.
6. Leave your retirement savings alone.
When faced with an unexpected large expense or financial emergency like a major home repair or job loss, it may be tempting to withdraw funds from a retirement account to pay for the expense. However, you should avoid this temptation if at all possible for several reasons.
First, tapping into your retirement account for non-retirement expenses will jeopardize your long-term financial security. Not only will these funds not be there for your retirement, but you’ll also lose the effects of compounding returns over time. And second, you may have to pay taxes and penalties on early withdrawals from your retirement account. For example, withdrawals from IRAs before age 59½ are generally subject to a 10% early withdrawal penalty. They’re also usually taxed at ordinary income tax rates.
7. Choose the right asset allocation.
This refers to how your retirement savings are divided between the primary asset classes of stocks, bonds, and cash equivalents. Generally speaking, the younger you are, the more aggressive you can be with your asset allocation.
For example, if you are in your 20s or 30s and still have decades until you plan to retire, you may be able to take more risk with your retirement investments because you have many years to make up potential short-term losses. In this scenario, you might choose an asset allocation that’s heavily weighted toward riskier stocks, such as 80% stocks, 10% bonds, and 10% cash equivalents.
But if you are in your 50s or 60s and nearing retirement, you might want to start shifting your asset allocation away from stocks and toward bonds and cash equivalents that are generally safer and less volatile. In this scenario, you could choose a less-risky asset allocation, such as 40% stocks, 40% bonds, and 20% cash equivalents.
Retirement Planning with Personal Capital
Personal Capital can help you implement these and other strategies for a financially secure retirement.
Millions of people use the free Personal Capital Retirement Planner. Using this tool, you can create a customized retirement plan, measure and monitor your progress toward meeting your retirement savings goals, and make any adjustments that might be necessary along the way.
Personal Capital compensates Don Sadler (“Author”) for providing the content contained in this blog post. Compensation not to exceed $500. Author is not a client of Personal Capital Advisors Corporation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.