We all know that we should be saving more money for retirement, but how do you make that happen? How do you go from nothing to maxing out all our tax-advantaged savings options like your employer sponsored retirement plan or individual retirement account (IRA)?
As I’ve mentioned in previous posts, my wife and I have been on this path for sometime. I’m proud to say that we currently have reached the maximum amount allowed for my 401k and for our Roth IRA’s. It wasn’t easy, but looking back I’m sure glad we did it!
So what steps did we take along the way to get to this point? Here is the strategy we used:
1. Maxing out your employer’s contribution.
When I first signed up for my 401(k) at work, I was very fortunate to receive some great advice – Contribute at least 8% because that’s the maximum contribution amount for our employer match.
If your employer kicks in any extra money on top of what you contribute, make sure you’re taking full advantage of it! Why? Because to not do so would be like leaving money on the table. Why pass up free money?
Where to look:
• If you’re starting a new job, sign up for it right away.
• If you’ve been working for a while, then go to work tomorrow and raise your rate. Don’t wait.
I still remember the PAIN I felt when my newly earned paycheck came back less than I was use to because of my new contribution. But as time went on, my spending and budgeting adjusted. You learn to live without it and don’t know any different.
Once you hit the contribution rate you need to get your employer’s maximum match, feel free to move on to the next step.
2. The Freedom of the IRA.
Beyond that 8% contribution, my next move was to contribute to an IRA. Why did I not just keep contributing to the 401k? Two reasons:
Employer plans like 401k’s and 403b’s are often criticized for being too limited on choices and for having higher than average fees. With an IRA, the terms are far different. You are free to choose almost anything and anyone you’d like to invest in: Mutual funds, stocks, ETF’s, CD’s, etc.
The other reason is because I feel as though you can do better with a Roth IRA than a traditional 401k. In my opinion, the Roth IRA was the better choice over the Traditional (click here to read my post why). As I’ve shown through example previously, your “effective” savings rate is much higher with a Roth. But don’t get too hung up. Investing in a Traditional IRA is still good. The point is to do it!
Where to look:
• Start with raises at your job. Each time you or your spouse gets a raise, take half of the percentage and apply it towards the IRA.
• Have you reviewed your budget lately? Could you be spending less on some of your expenses or credit cards? Are one of your major expenses about to expire? For example, my IRA savings got a big boost after our children started going to grade school and our daycare expenses dramatically decreased.
• What are doing this year with your income tax refund?
3. Turn Back to Your Employer Sponsored Plan.
So after a few years of pay raises and a few changes in our budget, we were each able to hit that $5,000 maximum contribution to the IRA. Where did we look next to stash money? Back to where we started.
After you take advantage of the IRA, go back to your employer retirement plan and work towards getting it to be fully funded. Why? Because your employer retirement plan is tax-sheltered and still has a big advantage over putting your money in the bank or using a normal brokerage account. Why pay 25% (or more) on taxes if you don’t have to!
Where to look:
• Again, look at your raises or review your budget. Each time your paycheck grows or your expenses decreases, this is an excellent opportunity to redirect that money to a sensible place. This may be slow, but it does work!
• Not getting that raise or is your budget already cutting to the bone? Find alternative methods for supplementing your income. See about part time work. Feeling really ambitious? Look at developing some form of passive income to bring in another revenue stream.
4. Above and Beyond
This is the point my wife and I are still trying to reach. Our plan is that once all our tax-advantaged savings accounts are all maxed out, we’ll turn to traditional investing in low cost mutual funds and stocks.
Now just because these aren’t “tax free” accounts doesn’t mean we’ll stop paying attention to the tax situation altogether. There are significant differences between short-term and long-term tax rates. In general, holding mutual funds and stocks for the long-term (over one year) has better tax advantages than holding them less than that. Want better? Dividends from dividend paying stocks are taxed at an even lower rate.
Please note that we haven’t fully exhausted all our tax-advantaged alternatives yet. For example, you could still invest in an annuity or life insurance policy. However, I will tell you that in my opinion the jury is still out on these two. Both are highly criticized for having extremely high fees and complicated rules. I will need to do more research before I can endorse either.
The Moral of the Story:
As the old saying goes, Rome wasn’t built in a day. And your retirement savings account certainly won’t be either.
You’re not going to save one million dollars in the first 10 years. In fact, it will probably take several years. Don’t get discouraged! Little by little, you will slowly build a fortune as long as you remember your priorities and stay disciplined.
Are you happy with your retirement savings rate? How do you boost your retirement savings and what strategies have you heard to max out these accounts? Please feel free to share.
Related Posts:
1) Browsing for Stocks – January 2012
2) Retiring on the One-Million Dollar Myth
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I was promoted last year. I instantly increased my 401K contribution to 20% from 12% to start investing more. I also liked your advice about investing in Roth IRA vs traditional IRA.
Nice job! You basically accomplished what it took me several years to get to. But as I always say – if you can afford it, then do it! You’ll only get to reap the rewards of compound interest sooner than later.
The whole story seem too convoluted to me, thanks to info such as this post and I am able learn about keywords and then research it further, so thank you for that. I already checked what’s the story with IRA with my friends who’s in the know about it. All that I have read your blog. Useful info and I like the passion you put in.
Thank you very much for your feedback. This blog is intended to provide financial advice to people of all levels – beginner to advanced. If my story seems convoluted, then that tells me I am not doing a good enough job of simplifying these matters. I really do want to make sure that people feel empowered to make educated decisions about their personal finance.
Geez, I didn’t mean *your* story is complex. I mean the whole story with saving accounts and taxes as a mess, but your blog helps me to show the path and better navigate it. You are doing great job
No worries! I’m glad to be of help!
Last year was the first (and only, for a while…) year that I maxed out the 401K and the Roth IRA. I am going back to school this year, but as soon as I find a full-time job, I am going to max out my accounts!
Good job getting there at least once! … And good job going back to school! I’m sure that when you return back to full-time work you will likely continue the good saving habit you have already started.
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I always wonder when I see these posts – are you talking about the full amount allowed by the IRS (ie 44,000/year) ? That seems like an excessive amount to put in retirement savings for most people. Only 17% of US households make 100k or more per year, and even if you are in that fortunate group this is 20-40% of your total income. How do you balance your retirement savings against other goals, given that there are substantial penalties for 401k withdrawals.
That’s a good question, and a lesson that I try to stress in many of my posts. My wife and I decided a long time ago that having enough money to retire (possibly early) was extremely important. We started off with just the simple 10% like everyone else. But over the years, every time we’d get a raise, we’d split it and raise our retirement contribution. When we’d get a profit sharing check or income tax refund, rather than wasting the whole thing, we’d put it in our IRA. When we’d finish making car payments or daycare payments, we’d continue to “pay” that money into our IRA’s. Yes, over many years we have built that number up to $44K (2 x $17K + 2 x $5K). I guess it always came down to what’s REALLY more important – putting the money towards a mature cause or blowing it on something frivolous? The fundamental to all of this is that we’ve always kept our lifestyles modest. Although we’re living much more extravagant lifestyles than we did when we first got married or started our jobs, we still live within a budget that is way below our means.
Read my post on using a 72T to take out your retirement money early without penalty before age 59-1/2. If we are ever lucky enough to need to, this will be one of those tax loopholes that we take advantage of.
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