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Investing to grow your retirement savings is a long-term project. The earlier you begin, the better, thanks to compounding interest.
You don’t have to worry about saving a lot at first. It’s all about forming a plan you can stick to.
Here are suggestions for retirement planning through the decades.
Your 20s: Open a 401(k) and IRA
You will likely land your first job in your 20s and can begin saving money for retirement. But before doing so, make sure you have enough cash to pay for three to six months’ worth of living expenses, in case an emergency arises. If you set up a retirement account and then withdraw from it to pay for emergency expenses, you may be subject to taxes and a penalty payment.
Once you have emergency savings, start funding a 401(k) if your employer offers one, especially if the company matches some of your contributions. If you turn down the option to contribute to a 401(k) plan that matches, you’re essentially giving away free money. In 2017, you can contribute up to $18,000 in a 401(k).
You also can open an individual retirement account, or IRA. In 2017, you can contribute up to $5,500.
If you can’t save enough to maintain both a 401(k) and an IRA, go for the 401(k) because contributions are automatic, pretax and subject to matching.
Your 30s: Consider a Roth, adjust asset mix
If you open an IRA in your 20s or 30s, you’ll want to consider a Roth IRA. Unlike a regular IRA, you don’t receive a tax deduction for contributions to a Roth. But when you withdraw money from a Roth IRA during retirement, it’s all tax-free. The money you withdraw from a regular IRA is taxed as regular income.
So if your tax rate is likely to be higher when you withdraw money from your IRA than it is now, you’re better off with a Roth IRA.
When it comes to allocating your retirement investments, try to put at least 60 percent in stocks during your 20s and 30s. But it all boils down to your risk tolerance. If you are unwilling to stomach losses, don’t put everything in stocks. The worst thing you can do is buy stocks and then sell them for a big loss.
Your 40s: Stay focused on the long run
Many people purchase homes in their 30s and 40s. It’s important to remember that your house is not part of your retirement plan, says Mick Heyman, an independent financial adviser in San Diego.
“I haven’t seen too many times that somebody buys a great home, sells it at 60 and then lives off the profits,” he says. So don’t spend so much money on a home that you can’t afford to save for your retirement as well.
You also must be realistic in providing for your children. Don’t spend so excessively on your kids that you neglect your retirement savings goals. That may even mean putting retirement plans ahead of your children’s college. Tuition payments can come from many sources, but retirement funds will have to come largely from the parents.
Your 50s: Capitalize on catch-ups
The 50s are the peak earning years for most people, so it’s even more critical to save. The government gives you some assistance, allowing increased contributions to IRAs and 401(k)s through “catch-up provisions.”
For IRAs, people 50 and older can contribute an extra $1,000 this year — $6,500 in total.
For 401(k) plans, participants 50 and older can put in an extra $6,000 — $24,000 in total.
If you have children who are now out of the house, you might have enough money to finance those catch-up payments.
Your 50s are a good time to opt for more safety in your asset allocation, experts say.
“Somewhere in your 40s and 50s, you want to transfer to more conservative stocks, and make sure you aren’t all in stocks,” Heyman says. “Start having 20 to 30 percent in bonds.” He also recommends orienting your stock holdings toward dividend-paying blue chips. They offer safety and income payments that you’ll appreciate during retirement.
Your 60s: Plan an income strategy
This is the decade in which you may well retire, which means you’ll begin withdrawing from your retirement funds.
The traditional rule of thumb is that you can cash out about 4 percent of your portfolio in each year of retirement. But with low interest rates limiting the amount of income your portfolio will generate, 3 percent may be more appropriate now.
Ideally, you should have two years’ worth of living expenses in cash to avoid having to dump your investments when markets are weak.
Adjust your asset allocation so that bonds account for a larger part of your portfolio, given your need for safety and income.
Paul S. Herman CPA, a tax expert for individuals and businesses, is the founder of Herman & Company, CPA’s PC in White Plains, New York. He provides guidance and strategies to improve clients’ financial well-being.