You’ll hear me talk about the urgency of planning for your financial future earlier rather than later, and being in your 30’s is a great time to really take it seriously. Einstein once said the most powerful force in this world was not his Atom bomb, but rather the power of compounding interest. To explain this simply, imagine you are standing on top of a mountain and you roll a snowball down the mountain. By the time the snowball reaches the bottom of the mountain it would have gotten larger and larger as it accumulated more snow, to the point where is almost might look comical. Compounding interest is pretty much the same as rolling the snow ball down the mountain. The larger the mountain the larger the snowball, and the longer you save the more you will have saved.
So today I want to help you by providing you with three savvy retirement tips to implement while you are in your 30s.
Savvy Tip 1: Stop procrastinating
As we saw in our snowball analogy, the larger your hill is (the longer you are invested) the more you will have saved. Also, the earlier you begin the less you will have to save on a monthly basis in later years. Let’s take a look at the difference between beginning to save when you are 35 versus beginning to save at 37.
Beginning at age 35:
Value at age 65
Beginning at age 37:
Value at age 65
Amount required to catch up by starting at 37:
Value At age 65
If we simply look at the difference two years will make we can see a pretty tangible difference of $177,000. I’m sure most of us would agree that difference is fairly significant, and that’s assuming only a two-year gap for when you start saving. Now let’s assume that you do decide to wait two years to begin saving for your retirement. Now instead of saving $750 a month you will have to save $890 a month to reach the same ending value you would have saved if you started just two years earlier.
Savvy Tip #2: Maximize your employer provided retirement account
Hopefully by now you have started contributing some amount on a regular basis to your 401(k) or other retirement plan through work. However, if you have yet to begin saving in your companies plan I recommend at least taking advantage of the companies matching contribution assuming they offer one. So now that you’re more established in your career, have some additional savings and have fallen in to your adult routine it’s time to bump up your 401(k) savings.
Two things you need to know about your employer provided 401(k) are really very simple. One: individuals under the age of 50 are allowed contribute $18,000 per year. Two: every dollar you contribute, up to $18,000 per year, is tax deductible!! So you actually avoid paying taxes on the money you set aside until you withdraw the funds later at retirement. I think you can see the benefits of contributing to your 401(k) given the opportunity to defer paying taxes as well as possibly receive a matching contribution from your employer.
Savvy tip #3: Diversify where you are saving your money.
In the world of investing and retirement planning you have several options as to the accounts you can invested. To put it simply you have tax-deferred accounts, tax free accounts and taxable accounts. We all have heard the saying don’t put all of your eggs in one basket, well the same can be said for don’t put all of your money in one type of account. I bring this up because at retirement having a diversified mix of money in all three types of accounts is extremely beneficial when we look at strategic retirement income planning.
Studies show holding the same amount of money and only a tax-deferred account or a taxable account will not go as far in retirement as holding a mix of taxable tax-deferred, taxable and tax free savings. Where this plays the largest role is in how large your future required minimum distribution (RMD) will be. As of right now at age 70 ½ you will be required to take a minimum distribution equal to the amount that you have saved in your tax-deferred accounts divided by 29.1.
For example, you $1 million saved in your IRA. Come age 70.5 your first required minimum distribution will be $34,364; all of which is taxable as ordinary income. Now let’s assume you have to take out more in order to maintain your current standard of living. Every dollar you pull out from their IRA is 100% taxable income, and the more you withdraw the more taxes you will incur as well as the faster, or be closer, you will get to jumping into the next higher tax bracket; thereby paying even more money in taxes.
Now it’s assume you have the same $1 million except you have it in two different accounts, one a tax deferred account and the other a tax free account. Being able to time your withdrawals between the two accounts will give you a greater amount of flexibility in order to maintain your desired lifestyle without running the risk of potentially over extending yourself tax wise. So if your first required minimum distribution at age 70 ½ is $34,000, but you need another 50,000 dollars to maintain your standard of living you have the option of taking it from the tax free account rather than the tax deferred account.
As you can see, the difference between the two scenarios above can be quite different with regard to the ending value of your savings. To summarize, diversification is important with your investments not only on a basis of how many different holdings you have but also on the basis of what types of accounts you utilize.
So I hope you enjoyed my 3 savvy retirement tips for your 30’s and let me know what you think. Do you think your savings will be enough to retire on? Do you think you will have the flexibility you need, or do you think it’s time to sit down and develop a plan? Feel free to contact me with any questions or if you want to schedule a meeting.