Related topics: retirement, retirement planning, 401k, IRA, financial planning
What does it take now to reach financial freedom in retirement? What sacrifices must be made? Here are strategies the experts suggest -- and how the rules of thumb have changed.
The first step is to get your debt under control and save as much as possible so you have a solid asset base going into retirement. How to do that?
"Simple," says Rande Spiegelman of Charles Schwab. "Spend less now. Living below your means has a twofold benefit: It allows you to build a nest egg that won't have to be even bigger to support higher spending," he said. "The alternative -- spending every last dime you make and going into debt to boot -- means getting used to a lifestyle you can't possibly afford when you are no longer willing or able to keep working. It would be like going from a luxury car to taking the bus."
Whether it's your financial or human capital, it's time to get the most out of what you have. This to-do list could be much longer, but here are a few things to consider.
1. Save 20% of your income. How much should you save? Since the crash of 2008, many rules of thumb have changed. Now some experts say that saving at least 20% of your income is the proper goal. Why so much? Two reasons:
- Many Americans are not saving enough to build a nest egg that, combined with other sources of retirement income, such as Social Security, pensions and earned income, will replace 85% of their pre-retirement income.
- Investors are now somewhat more conservative with their investments in the wake of the market rout. Taking on less risk means a lower expected rate of return -- which means saving more.
2. Know where your assets are. It's likely you have some money in tax-deferred accounts such as IRAs and 401k's and some in taxable accounts. If so, consider investing so that your assets produce the greatest after-tax wealth. Your fixed-income investments, those subject to ordinary income tax, should be in your tax-deferred accounts, while equity investments, those subject to capital-gains or dividend-income tax, should be in your taxable account.
Most investors tend to overlook where their assets are located, said Mark Cortazzo, a certified financial planner and senior partner with Macro Consulting Group. Paying attention to asset location could boost your overall after-tax investment returns by 20 basis points, or one-fifth of 1%, per year, according to a landmark paper on the subject (.pdf file).
3. It's time to convert to a Roth. It's impossible to say whether you'll be in a lower or higher tax bracket come retirement, but wouldn't it be nice to be able to withdraw your money from whichever account produced the greatest after-tax income? That's why you should consider investing in a Roth IRA or Roth 401k as well as traditional IRAs and 401k's. By having both a Roth and traditional accounts, you have the option of withdrawing from whichever account you want, until you turn 70-1/2 and have to take required minimum distributions from your traditional IRA.
If you've waited until now to convert, you're in luck. Uncle Sam has lifted the income limits that prevent high-income earners from converting their traditional IRAs to a Roth. Plus, new tax rules allow those who converted to a Roth in 2010 to spread the taxes due over 2011 and 2012.
