Whether you’re living paycheck to paycheck or have been blindsided with unexpected expenses, hitting the big 4-0 with nothing in the bank for retirement isn’t ideal.
Before we get into what you should do about it, this might make you feel a tiny bit better: lots of other people are in the same predicament. Almost half the respondents of the Federal Reserve’s latest Report on the Economic Well-Being of U.S. Households said they had no financial plan for retirement, and U.S. News reports that about 36 percent of American workers have less than $1,000 saved for their post-work years.
Regardless of your why, it’s not too late to take a hard look at your finances, devise a plan, and get some money in the bank. Here’s a step-by-step guide to whipping your retirement savings into shape.
Step One: Crunch Some Numbers to Outline a Basic Retirement Plan
the number of years you’ll depend on your retirement savings
an annual estimate of living expenses in retirement
your current savings.
Since these numbers are a vital part of your plan, let’s talk about how to identify them.
While many people think of 65 as the “normal” retirement age, it’s not a definitive age. As people live longer, some choose to work into their late 60s and beyond. Taking into account your age, salary, expenses and how long you’re likely to live, you can figure out what age is a realistic retirement target.
Remember to consider any potential income you might have in retirement. Will you have a pension, or will you depend on Social Security? To calculate your Social Security payments, enter your birthdate and current salary into this Social Security calculator from the U.S. Department of Labor. Test out different retirement dates to see how retiring a year or two earlier or later could affect your monthly payments. For example, a 40-year-old earning $50,000 a year can expect benefits of $1,517 per month if she retires at age 65, or $1,766 if she waits until age 67.
Now run your numbers through the AARP’s Retirement Calculator. Enter your age, salary and lifestyle details, and it creates a graph that shows your estimated retirement income and projected living expenses, as well as any gap between the two. Adjusting your planned retirement age helps show how working an additional year or two could affect your savings.
Let’s look at an example: a 40 year old, unmarried female investor who earns $50,000 per year and has no retirement savings is looking at a significant gap between her retirement income (only Social Security) and projected expenses. Even delaying retirement until she’s 67 doesn’t close the gap; she’ll need to rely on savings as well.
How much money should you be saving? Morningstar’s Retirement Savings Calculator uses your age, salary and current savings to determine how much of your annual income should go toward retirement savings. Be prepared for a wake-up call: a 40-year-old earning $60,000 should aim to save 17 percent of his annual income — and that’s assuming he or she already has $10,000 in the bank.
If you’re not sure where that money is going to come from, it’s time for Step two.
Step Two: Assess and Trim Your Living Expenses
Seeing a gap between your estimated retirement income and living expenses can be sobering. To start closing that gap, let’s take a hard look at your spending.
Categorize your expenses into “needs”, “wants”, and “savings”. Needs are basic essentials like food, housing and utilities. Wants are less necessary expenditures like clothing, travel or entertainment — and they’re your first target for cuts.
Slash spending from your “wants” category by identifying and cutting out unnecessary expenditures. These will be different for everyone; for ideas, check out the responses from Lifehacker readers when we asked what people tend to cut back on first
Don’t be too harsh, since eliminating everything you enjoy is unsustainable, but be as ruthless as possible. You might not quit Starbucks coffee cold turkey, but maybe you can brew their beans at homeinstead of hitting the drive-through every morning.
If you’re ready for a big change, consider downsizing your home. Buying a cheaper residence frees up more of your money and often decreases your bills, as Steve Gillman explained when describing why he traded his house for a cheaper condo. Bonus: not all your stuff will fit in the new place, and that might be a good thing. Sell it for extra cash, or donate it for a tax write-off.
Savings aren’t immune, either. While you might not have banked any money toward retirement, you might have been planning for a vacation or a new car. Earmark that money to your retirement instead.
Finally, if you’re still supporting your adult children, it’s time to tell them they’re on their own. It sounds harsh, but as U.S. News points out, they have many more years for their own financial planning.
Total the amount you’ll save each month from these changes. This is your first retirement contribution.
Think your living expenses are already as trim as possible? Then move onto Step three.
Step Three: Consider New Opportunities to Earn
While cutting spending can help you find a little extra money to put toward retirement, there’s only so much room in most budgets. Once you’ve cut what’s reasonable from your expenses, it’s time to focus on earning more money.
Next, look outside of your 9-to-5. Rent a room or suite in your house, or start a side business. Switch to a credit card that offers cash back on your purchases. For more ideas, check out this massive post on making money in your spare time. Route any additional earnings straight to your retirement accounts (more on those in a moment).
Another option is to consider working a part-time job once you retire, says Trent Hamm of The Simple Dollar. He points out that not only does the extra income boost weak retirement accounts, but the social connections and sense of purpose can help retirees stay connected to their communities.
Consider whether there’s an opportunity to continue in your field after retirement, such as consulting at your former full-time employer or sharing your experience at a local community college. If you’d prefer to try something new in retirement, consider some of these strategies from Money Magazine. When we return to our example of the 40-year-old female investor, we can see how working part time after she retires at age 65 could help her support herself.
Total the amount of “extra” money you’ll have each month. Tallying regular income, such as a raise or rent payments, is easier than irregular earnings, such as those from a side business. Choose a rough estimate based on your earning opportunities, and adjust it as you start earning more money. Remember, every penny helps bolster your retirement savings.
Now it’s time to put your money to work in a retirement account that’s right for you.
Step Four: Optimize Your Retirement Contributions
Many employers match 401(k) contributions up to a certain percentage. If yours does, you’ll want to take advantage of this “free” money. Not sure? Schedule a meeting with HR.
If your company offers a match, contribute the money from your lowered expenses and new earning opportunities to your 401(k) up to the match. Calculate how much you need to contribute each pay period to max out the match by the end of the year, and set up automatic transfers from your checking account after each payday.
If your employer doesn’t offer a match, you might be better off focusing on an IRA first, but don’t write your 401(k) off entirely, recommends personal finance and behavioral psychology expert Ramit Sethi.
While investment experts can make strong arguments for both traditional and Roth IRAs, your decision comes down to whether you want to be taxed on your contributions now or later. The general rule of thumb: if you’ll be in a higher tax bracket in retirement than you are now, you should choose a Roth IRA. If you’re earning more now than you will when you retire, you should go with a traditional IRA. Check out this beginner’s guide to IRAs, and Charles Schwab’s IRA calculator to help you make the decision.
Whichever IRA you choose, set up automatic transfers from your checking account. This way, you won’t see the “extra” money you’ve saved from canceling or downgrading your bills; it’ll go straight into your retirement account. Even small contributions count: you can open an IRA with as little as $10, and that money will grow over time.
Once you’ve opened a retirement account, it’s time to help your money grow.
Step Five: Choose and Strengthen Your Investments
Wondering what to invest in? Here’s a guide to choosing investments for your retirement accounts. Since you’re only about 25 or 30 years away from retirement, you won’t want to invest as aggressively as a 20-year-old might, but you should still find a good mix of options. Index funds are often a good choice, though you’ll want to make sure to balance your portfolio with “safer” investments like bonds or certificates of deposit. They may not earn as much, but they’ll protect you in case of a rollercoaster market.
Since you’re contributing to your accounts each month, help them grow more quickly by adding as much extra cash as possible. Add any windfall money — like a birthday gift or a tax return — to your retirement accounts to boost your bottom line. If any of your investments pay dividends, reinvest them so your money grows faster.
All set? You’re not quite finished; it’s time to check your work.
Step Six: Test Your New Retirement Plan
Now that you’ve put a retirement plan into action, put it to the test to make sure you’re on the right track.
Update your estimates on the AARP Retirement Calculator. If you’ve closed the gap between your estimated retirement expenses and income, congratulations! If not, spend a month or two adjusting to your initial plan, then revisit Steps 2 and 3 to identify additional saving and earning opportunities.
Let’s go back to our earlier example of a 40-year-old, unmarried female investor who earns $50,000 per year. If she starts saving 10 percent of her income each year ($5,000) and works until she’s 67, she’ll be much closer to her retirement goals.
Planning for retirement isn’t simple, especially if you’ve waited until your forties. But the sooner you start, the better off you’ll be.