9 Step Guide to Save Towards Retirement
Ever thought about retirement or save towards retirement? It’s never too late or too early to think about it. Saving for retirement now can change your mindset in having to work vs. wanting to work. I will show you how you too can be on the path of achieving your own financial independence by simply following these 9 steps on saving towards retirement.
Step 1: Make a Budget and Stick With It
First thing financial planners always suggest is create a budget. This is will be one of your key performance indicator as budgeting allows you to see where all your expenses are going. There are two main expenses in your budget; one is fixed expenses and the other is variable expenses. Fixed expenses are definite expenses that can not be easily changed (i.e. car payments, mortgage/rent, insurance, phone bill, etc). The other being variable expenses. Variable expenses are not definite and you can control the change of these amounts. Like how much you can spend on dining, entertainment, and general expenses (gas, groceries, clothes), etc. These are expenses you should focus on trying to keep low each month.
Step 2: Set SMART financial goals
Think through the questions in the picture above. Are you planning to buy a house, retire early, or just want to get out of debt? Having this goal in mind will be a great motivator. This is also a great way to track your progress.
Step 3: Create an Emergency Fund
This amount can vary depending on your needs. Keep an emergency fund that can cover your expenses at least up to 3 months. So for an example if you have a monthly expense of $2,000 a month. You would want to save up a minimum $6,000 as an emergency fund. The reason why you should do this is because unexpected things do happen; like losing your job, car problems, and medical emergencies. You want some extra cash to cover expenses should you ever need them. The best locations to save these funds are in a liquid asset or high yield savings account. That way you have quick access to these cash when needed.
Step 4: Match Employer-Sponsored Plans (Most Common 401Ks)
If your company offers a 401k and a employee contribution match. You definitely need to take advantage of this because you’re basically tossing away free money. For an example, if your employer matches 100% on your first 6% of your contributions. If you have an annual salary of $60,000 and you’re contributing 6% of your paycheck each pay period. Throughout the year you’ll have saved at least of $3,600 into your 401K. However, with your employer match ($3,600) your total 401K balance for the year will be now be $7,200, which is double the amount. Additionally, when it comes to tax season these contributions are pre-tax contributions. Meaning it is deducted from your income and you avoid paying taxes on them.
Step 5: Pay Your Debts
There are two common methods in paying your debts,the snowball method or the avalanche method.
The avalanche method is paying your highest interest rate debt balances first, regardless of amount owed. While the snowball method is paying your smallest debt balances that you owe, regardless of interest rates.
Personally, I would suggest the avalanche method only because from a financial standpoint you’re paying less money in the long run rather than the snowball method. Some will suggest the snowball method because it’s a great motivator to see debt balances hit $0 and it keeps you motivated through the end. You should decide which you’re more comfortable with.
Step 6: Maximize Contribution to Health Savings Account
After all your debt has been cleared. You should start focusing on maximizing other tax advantage accounts but first priority is the Health Savings Account (HSA). I can go into detail as to why this is maybe the ultimate retirement account but Mad Fientist can explain this better in his post. This tax-advantage account has three benefits worth getting this account which are 1) tax-free contributions, 2) tax-free growth, and 3) tax-free distributions. Some companies also provide incentives like a matching bonus if participating in a HSA. So what’s not to like about this account?
Step 7: Maximize Contributions to Traditional/Roth Individual Retirement Accounts (IRA)
After you maximize your HSA account, next account you should maximize is a Traditional/Roth IRA. Now the main difference between a Roth and a Traditional IRA is taxes paid. Traditional accounts are pre-tax contributions meaning you defer taxes and pay on the back-end when you withdraw. While the Roth accounts are post-tax contributions and the exact opposite of Traditional where you pay taxes up front. Each individual will have their own preferences on which account to get. For aspiring early retirees like myself, I favor Traditional accounts because I want to defer my taxes now during my working years and then convert them later to a Roth once I retire. Then after 5 years, I can withdraw these amounts at an earlier age without penalty. This technique is called the Roth IRA Conversion Ladder.
Step 8: Maximize Contributions to 401K
Now we finally get back to the 401K plan. After contributing up to the employer match for 401K, maximizing your HSA, and maximizing your IRAs you want to go back to your 401K and contribute up to the maximum limit. Unlike the IRAs, which are capped at $5,500 contribution limit a year. 401K accounts allows you to contribute a maximum of $18,000 per year and starting in 2017 it will continue to be indexed to inflation ($500 increments). Which is an exponential boost of tax-advantage contributions.
Step 9: Save or Invest in a Taxable Account
Last but not least any excess money you still have to save you should invest them in a taxable investment account (i.e. Vangaurd or Fidelity brokerage). Another option, especially those of you with kids, I would suggest taking a look at 529 College Saving Plans as this is another tax advantage account you’re eligible for.
I hope this quick step guide on how to save towards an early retirement or other financial goals in mind helps you out. For those that are more visual aid readers than informative here is a quick summary graph of the steps you should take towards early retirement.
Any other saving techniques that I didn’t cover? Please leave a comment below.