If you asked a search
engine how to save for retirement, you might see a bunch of advice on working
the perks in your 401(k). And that's great information – unless you're one of
many Americans who doesn't have a workplace retirement plan. In that case,
learning about employer match or vesting schedules may help resolve your
insomnia, but it won't help you reach your retirement goals.
Though the 401(k) might be a popular way save for
retirement, it's not the only way. The first challenge you're likely to see
when saving without a 401(k) is making savings contributions, month in and
month out. The 401(k) automates this for you by pulling the money straight from
your paycheck. Mimic that system by setting up auto transfers from your
checking account, timed to fall on the day your paycheck is deposited. After
that easy step, you're already on your way to retiring a millionaire.
As for where to put your monthly savings deposit, that
depends on how old you are. Below are two strategies to build a seven-figure
retirement account. The first and simplest approach is effective if you're in
your 20s. But if you've already seen your 30th birthday come and go, take the
second approach.
1. Max out your IRA contributions for 40 years
If you are in your early 20s, congratulations are in order,
because you have options. With 40-some years ahead of you to save, you don't
need a 401(k) to reach your seven-figure savings goal. A traditional or Roth
IRA can do the job on its own.
A compound earnings calculator will tell you that you can
reach $1 million by saving $400 monthly for the next 40 years. That assumes you
have those savings invested to earn 7% after inflation and taxes. That's
reasonable, considering 7% is roughly the average, long-term growth rate of the
stock market after inflation. You don't have to worry about year-to-year taxes,
because the earnings in your IRA are tax-deferred.
Sounds easy, right? It is, but there are some pitfalls that
can derail this millionaire plan. The first one is investing in the wrong
securities. If you're new to investing, the simplest path is to lean on index
funds, such as the Vanguard 500 ETF (NYSEMKT: VOO). This fund gives you a slice
of 500 of the largest publicly traded companies in the U.S. You'll see near
market-level returns without too much work on your part. In the meantime, look
to broaden your investing knowledge so you can expand your portfolio later.
A second pitfall is moving in and out of the market because
you're worried about volatility. That strategy often results in lower overall
returns, even as you're trying to prevent unnecessary losses. This happens
because you often end up missing the market's best days instead of the worst
ones. According to a 2020 J.P. Morgan report, the market grew about 6% annually
between January 2000 and December 2019. But if you had missed the market's 10
best days during that time period, your average returns would have dropped to
less than 2.5%.
The takeaway here is to stay in the market, even when it
seems like everyone else is selling. You'll be better for it.
2. Contribute to IRA and a taxable account
If you are older than 25 or 30, your millionaire retirement
plan will require an extra step. Here's why. The amount you can contribute to
an IRA each year is limited. In 2021, for example, you can deposit up to $6,000
total across all your IRA accounts until you turn 50. If you're 50 or older,
you can contribute up to $7,000. That equates to $500 monthly or $583 monthly
after 50. And even if you have a full 30 years to save, a $500 monthly
contribution won't get you to $1 million.
That means you'll have to max out your IRA contribution each
year and additionally save to another account. Your second account can be a
taxable brokerage account. You will pay taxes on the realized gains, dividends,
and interest earned in that account each year, but you won't have any
withdrawal restrictions. You can keep your tax bill low by investing in
tax-efficient mutual funds and non-dividend-paying stocks you can hold for long
periods of time.
The total amount you'll need to save monthly depends on how
many years you have between now and retirement. You can use the SEC's savings
goal calculator to run the numbers. Use 6% or 7% as your estimated interest
rate, which assumes you'll be invested in the stock market. The calculator will
return your monthly savings target. Plan on investing the first $500 in your
IRA and any amount over $500 in your brokerage account.
Don't wait for a 401(k)
When it comes to retirement saving, it's critical to get
started early – and that's especially true if you don't have a 401(k). Waiting
even a few years can dramatically increase the amount you need to save each
month to reach your goals. Wait 10 or 20 years and you may see your retirement
wealth goals slip out of reach. Also know that even if you can't save as much
as you'd like, saving something is better than saving nothing.
So get to it. Today's the day you put your millionaire
retirement plan into action.
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