7 Tips for Saving for Retirement if You Started Late
Imagine that you recently opened your 40th birthday cards and finally decided to learn about retirement savings. You've even bought a retirement book or magazine. Except, it says you should have started saving for retirement in your 20s; you're well past that age and still haven't started saving for retirement. Fortunately, you do have options even if you didn't start saving for the future on time.
Play Catch-up in Saving for Retirement
Assume you're 40 years old, with $0 in retirement savings. At your age, in 2021, as in 2020, you're legally allowed to save $19,500 in a 401(k) retirement plan ($26,000 if you're 50 or over).
Assuming a 7% rate of return, your 401(k) account balance will grow to $1 million in 22 years and 10 months if you contribute the maximum amount each year. You'll be on track to have over $1 million by the age of 63. As you can see, the magic of compounding makes it possible to realize your retirement savings goals even if you start late.
Identify How Much Savings You Need
You might tell yourself you don't need a million dollars or that you just want a simple life. But even a simple life often 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 "3 percent" and "4 percent" retirement rules.
If you do the math, 3% of $1 million is $30,000, and 4% 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 you don't have a pension, rental properties, or other sources of retirement income. It also excludes Social Security, which some 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 20s can accept greater losses since they have more time to recover. People in their 40s cannot.
Don't accept extra risk in your portfolio. You might consider one of the following asset allocation recommendations:
- Invest a percentage of 120 minus your age in stock funds, with the rest going into bond funds. This represents a high but acceptable level of risk.
- Invest a percentage of 110 minus your age in stock funds, with the rest in bond funds. This comes with a more moderate level of risk.
- Invest a percentage equivalent to your age in bond funds, with the rest going into stock funds. This is a more conservative level of risk.
Open a Roth IRA to Save More
Once you're finished maxing out your 401(k), 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.
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 50s.
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.
Many financial experts say that whole life insurance is generally not as affordable an idea, especially if you're starting the policy in your 50s.
Pay Down Debt
Pay off credit card debt, car loans, and other high-interest or non-mortgage debt. Similarly, weigh whether or not you should make extra payments on your mortgage. If you're in an 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 for retirement.
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. They can also take out student loans. Your 401(k) may or may not allow you to take out a loan on your retirement account balance.
Plus, your kids have their entire lives ahead of them. They can start saving for retirement in their 20s and 30s. If you're in your 40s, you can't turn back the clock and regain those decades of saving for retirement. As such, the best gift you can give your children is your own financial retirement security.