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Remember the story about the tortoise and the hare?
The hare assumes he’ll win a race against the tortoise. After taking an early lead, the hare stops to nap. While he’s resting, the tortoise passes him, keeping a slow and steady pace to win the race.
This fable has a relevant moral for your retirement planning: it pays to build a secure financial future over time.
But what if you counted on amassing your retirement savings quickly, close to retirement? Don't worry, there's still time to become tortoise-like. Here's how.
Time is on the side of young retirement savers. That’s due to the magic of compound interest: the earnings from your account’s early years generate earnings of their own as time goes on. The sooner you start investing, the more time those earnings have to grow. Begin a program as soon as you can to take advantage of as much compound interest as possible.
How much can it help? If you invest $1000 when you turn 25 and earn 7% on it each year until retirement, you’ll end up with almost $15,000 — even if you make no further contributions. You’d have to invest about $1,400 at age 30 — or $3,800 at age 45 — to get similar results.
Know where you stand when it comes to retirement savings. For guidance, consider the 80% rule. In other words, plan to save enough to replace 80% of your annual pre-retirement income.
Then figure out how much you can safely set aside each month by calculating your recurring monthly expenses and anticipated income. If you’re not able to save much, consider taking a side job and devoting all your profits to retirement.
Remember that the amount of money you’ll actually need can change, even as your retirement nears. For example, your empty nest might become reoccupied. Living with parents is now the most common housing arrangement for 18- to 34-year-olds, according to a 2016 study by the Pew Research Center. Changes of plans like these can mean you need more cash than you anticipated.
If your employer offers a 401(k) and matches a portion of your contribution, putting in enough to get the maximum match is a no-brainer. Once you’ve earned your 401(k) match, don’t stop there! You can contribute up to $18,000 a year (or more, if you are over 50), not including your employer match.
Once you max out your 401(K), consider an IRA. There are two types of IRA: Roth and traditional. With a Roth account, you pay taxes up front, the investment and earnings grow tax-free, and your distributions in retirement aren’t taxed. Traditional accounts work the other way: you pay tax only when you take distributions during retirement. If you expect your tax rate to be higher in retirement than it is now, a Roth IRA is likely the better choice. If you think it will be lower, you might choose a traditional.
Both 401(k)s and IRAs have annual contribution limits — $18,000 and $5,500 respectively. But if you’re age 50 or older, you can make catch-up contributions of $6,000 per year to a 401(k) and $1,000 per year to an IRA. If you were a late saver, use these features to build more tax-advantaged savings.
If you’ve maxed out your 401(k) and IRA and still want to save more, consider a traditional brokerage account. There are no tax advantages, but it’ll still mean more cash when it comes time to retire.
Check with your employer to see what services and assistance they offer with saving. Look for other retirement savings tips at a financial institution like Dominion Energy Credit Union. And don’t forget to channel your inner tortoise.
Peter Lewis, NerdWallet © Copyright 2016 NerdWallet, Inc. All Rights Reserved