Saving for retirement can be a sore subject for Americans approaching their golden years.
With so much gloom-and-doom surrounding Social Security -- a 2011 report from the Social Secuirty Board of Trustees said Social Security will be insolvent by 2017 -- a self-funded retirement is more of a reality for many Americans.
The average person lived 16 years longer in 2007 -- most recent year for which data was available from the U.S. Centers for Disease Control -- than they did in 1935 when Social Security was introduced. So, even without inflation, the number of dollars needed to sustain a retiree has gone up.
For those planning to retire by 65, their retirement fund will need to be big enough to replace their income for at least 12 years. According to a 2012 survey by the Employee Benefit Research Institute, nearly half of U.S. workers say they don't feel confident they will have enough money to live comfortably through retirement. In other words, these workers will have to lower their standard of living once their working income stops.
Here are some steps to increase your savings as quickly as possible:
Step 1: Shrink Your Expenses
Achieving a retirement savings goal means living below your means, which is why lowering your monthly expenses is critical. While you work, a lower cost of living allows for more savings, and when you retire, it means your savings will last longer.
Start by eliminating any high-interest debt, such as credit cards or unsecured loans. Even if your house is paid for, if it's too large or requires constant maintenance, it could become a financial burden. Consider selling your home and downsizing to a smaller, more affordable one with minimal upkeep.
If you pay off your mortgage early, you can channel the money you paid on your mortgage toward your retirement savings. For instance, if you invested an extra $700 a month at an 8% rate of return, in just six years you'd have an extra $78,469 in your retirement account.
Step 2: Max Out The Match Point on Your 401(k)
If your employer offers a 401(k) plan, make it a priority to max out the matched contributions. It's essentially free money going toward your retirement savings. Some employers match 50 cents for every dollar (usually up to 6% of your salary), while others match 100% of your contribution up to 3% - 6% of your salary.
For example, if a worker earning $50,000 per year invests 3% of his income with an employer who matches him dollar for dollar, $250 a month will go into his 401(k). If he does this every month for 15 years and the account gets an average of 8% interest over time, he'll end up with $86,509.
Any money you contribute to the fund is tax-deductible. Schedule a meeting with your financial advisor to find out the details of your 401(k) investments and your company's matching policy.
Step 3: Create an IRA Supplement
In addition to a 401(k), it's also good to have an IRA account for the tax advantages and the favorable rate of return. It's also a way for self-employed, business owners, or employees without an employer-sponsored plan, to invest for retirement.
Roth IRA investments allow investors to contribute after tax funds into the account. The contributions are limited to $5,000 per year, but they are increased to $6,000 per year if you're over 50 years of age. Once you are 59½ years of age, the money can be withdrawn tax-free and without penalty, provided the funds have been in for at least five years. They also do not require withdrawals at any age, so the funds can keep growing as long as the investor wants to keep them in the account.
Contributions to a traditional IRA are tax-deductible, which makes it cheaper and easier to invest on the front end. However, once you access the funds after age 59½ you will need to pay taxes on the amount you withdraw. The funds must be withdrawn before you turn 70½ years of age, if you want to avoid penalties and taxation.
Step 4: Diversify Your Retirement Assets Carefully
During an economic downturn, your retirement accounts could take a major hit, and withdrawing before investments level out could mean big losses.
A well-diversified retirement portfolio means you are more likely to benefit when an industry booms. That's why your portfolio needs domestic and foreign stocks, as well as fixed-income investments like equities and bonds.
Your investments should have little to no risk in last couple of years before you retire; should your high risk investments face large dips on the eve of your retirement, you won't have time to recover money lost.
Step 5: Extend Your Working Years
One of the simplest ways to catch up on retirement savings is to work longer. This will give you more time to save for retirement and will also increase your Social Security benefits.
According to the Social Security Administration, if you retire at age 62, your benefits could be about 25 percent lower than they would have been if you had waited until full retirement age. For people born between 1943 and 1954, that age is 66 years old. If you were born in 1960 or later, full retirement age is 67. (For those born from 1955 to 1959, check SSA.gov for your full retirement age. Each of those years is different.)
Wait even longer and the payoff gets even greater. The SSA says that if you were born in 1943 or later, 8 percent per year will be added to your benefits for each year you delay retirement.
The Investing Answer: Reaching a retirement goal on time requires aggressive saving, maximizing tax advantages, lowering your expenses and keeping a diversified investment portfolio. As the old Chinese proverb says, "The best time to plant an oak tree was 20 years ago, and the next best time is today."
-- By John-Michael Haines