7 Tips for Saving for Retirement if You Started Late

How to Save for Retirement with a Late Start: Avoid extra risk in your portfolio Open and make maximum contributions to a Roth IRA Make sure you have adequate insurance (health, car, etc.) Pay off debt Don’t skimp on retirement savings to send your children to college

Image by Julie Bang © The Balance 2020

After you opened your 40th birthday cards, you realized you should learn about retirement savings. You bought a retirement book or magazine, which said—oops—you should have started saving for retirement in your twenties. You didn't start saving for retirement early. Now what? You do have options even if you didn't start saving on time.

Play Catch-Up

Let's assume you're 40 years old, with $0 retirement savings. At your age, in 2020, you're legally allowed to save $19,500 in a 401k retirement fund. How far will that money go?

Assuming a 7% rate of return, your 401k will grow to $1 million in 24 years and two months. That means you'll be on track to have $1 million by the age of 64, in time for retirement.

You'll need an extra seven years to have an inflation-adjusted $1 million, equivalent to today's dollars. In other words, you'll have an inflation-adjusted $1 million by the age of 71, assuming you keep contributing $17,000 per year. Since many retirees work until the age of 68 or 70, working for an extra seven years could be a feasible goal.

Understand How Much You Need

"But I don't need a million" you might be thinking. "I just want a simple life."

Ah, but a simple life requires $1 million in the bank. Most experts agree that during your retirement, you should withdraw no more than 3% to 4% of your retirement portfolio each year. These are known as the "4 percent rule" and the "3 percent rule."

Three percent of $1 million is $30,000. Four percent of $1 million is $40,000. In other words, if you want to live on an income of $30,000 to $40,000 per year in retirement, you'll need a portfolio of at least $1 million. This assumes that you don't have a pension, rental properties or other sources of retirement income. It also excludes Social Security, which many people find to be more paltry than they expect.

Don't Take on More Risk

Some people make the mistake of taking on additional investment risk to make up for the lost time. The potential returns are higher: Rather than 7%, there's a chance that your investments can grow 10% or 12%. But the risk, the potential for loss, is also much higher. Your risk should always, always be aligned with your age. People in their twenties can accept greater losses since they have more time to recover. People in their forties cannot.

Don't accept extra risk in your portfolio. Pick one of the following tried-and-true asset allocation recommendations:

  • 120 minus your age in stock funds, with the rest in bond funds—the highest acceptable level of risk.
  • 110 minus your age in stock funds, with the rest in bond funds—a moderate level of risk.
  • Your age in bond funds, with the rest in stock funds—the most conservative acceptable level of risk.

Open a Roth IRA

Once you're finished maxing out your 401k, open an IRA and maximize your contribution to that as well. A 40-year-old who is eligible to fully contribute to a Roth IRA can add extra money each year to their retirement savings.

Contributions to a Roth IRA grow tax-free and can be withdrawn tax-free. You'll even avoid capital gains tax.

Buy Adequate Insurance

Calamities are the single biggest reason that people are forced to declare bankruptcy. Reduce your risk by buying adequate health insurance, disability insurance, and car insurance.

If you have dependents, consider term life insurance for the duration of the time that your dependents will rely on you financially. Many financial experts say that whole life insurance is generally not as good of an idea, especially if you're starting the policy in your fifties.

These are just general observations. Talk to a fee-only financial planner to get personally-tailored advice. Look for planners who have a "fiduciary duty" to you as their client.

Pay Down Debt

Pay off credit card debt, car loans and other high-interest or non-mortgage debt.

Weigh whether or not you should make extra payments on your mortgage. If you're in the early stage of your mortgage, and many of your payments are being applied toward interest, it might make more sense to make extra mortgage payments.

If, however, you're in the final years of your mortgage and your payments are primarily being applied to the principal, you may be better off investing that money.

You and Your Spouse Come First

Don't skimp on retirement savings to send your children to college. Your kids have more options and opportunities than you do. Your kids can take out student loans. You can't take out a "retirement loan." Your kids have their entire lives ahead of them. Time is on their side. Time is not on your side. Your kids can start saving for retirement in their twenties and thirties. You cannot. The best gift you can give your children is your own financial retirement security.

Article Sources

  1. Internal Revenue Service. "401(k) Contribution Limit Increases to $19,500 for 2020; Catch-Up Limit Rises to $6,500." Accessed July 16, 2020.

  2. U.S. Securities and Exchange Commission. "Individual Retirement Accounts (IRAs)." Accessed July 16, 2020.

  3. HavenLife. "You’re in Your 50s. Should You Buy Life Insurance?" Accessed July 16, 2020.