Retirement planning for people in their 30s
You work hard and your paycheck reflects your achievements. But, at the same time, there is a dizzying array of new ways to spend. Maybe it’s saving for your first home or you just signed on the dotted line for a hefty mortgage. There may be one baby, or more, to provide for. Even the dog is begging for more food.
- Ramp up 401(k) savings.
- Save outside of work, too.
- Maintain an aggressive asset allocation.
- Keep company stock in check.
- Don’t let a better job derail your retirement plan.
- Start preparing for college.
- Protect your earnings with disability insurance.
To be sure, establishing a home and family is expensive, and it’s easy for retirement to seem like an impossible goal for individuals in their 30s.
“You can’t always do it all,” says Dick Bellmer, chairman of the National Association of Personal Financial Advisors.
So breathe easy. You won’t have to reach all of your goals at once. But, retirement should remain your top priority. That means you’ll need to work hard to balance spending with saving. Here’s how:
1. Ramp up 401(k) savings
Ideally, you’ll want to make the maximum annual contribution limits into an employer-sponsored fund, such as a 401(k). For 2007, that’s $15,500. As you move up the career ladder, put raises into your retirement savings, don’t spend them. If you can’t afford to stash all of your pay increases into retirement funds, gradually increase contributions over time, says Dee Lee, a Certified Financial Planner and author of “Women & Money.”
“Let’s say you’ve got 3 percent in your 401(k) to qualify for the company match. Add a bit more. Then maybe add another percent of your salary a few months later, so eventually you’re saving 10 to 15 percent of your income,” says Lee. “You won’t miss the money if you increase saving slowly.”
You’d be surprised the difference that even an incremental, 1-percent increase can make in the long run. For example, a 30-year-old who saves 6 percent of a $50,000 salary, or $3,000 a year, will have nearly $840,000 banked by the time she has to start taking funds from her 401(k) at age 70½. (This assumes an 8 percent annual growth rate.) If she boosted her yearly contribution by just $500 she’d have nearly $980,000. That’s a difference of nearly $140,000.
2. Save outside of work, too
If you’re already putting as much as you can into a 401(k) or other employer-sponsored fund, pat yourself on the back, then open a separate, personal IRA. This year, individuals under age 50 can save up to $4,000 in a Roth IRA, a deductible IRA and a nondeductible IRA, subject to income limits.
Which one’s best for you? Ed Slott, editor of www.irahelp.com and author of “Your Complete Retirement Planning Road Map,” believes that everybody should open a Roth if they can. That’s because you save with after-tax dollars but the earnings on your investments grow tax-free forever. Plus, unlike many other retirement plans, you never have to cash out a Roth. Earnings can grow as long as you want.
Now for some fine print: In 2010, anyone can convert to a Roth IRA. Until then, you’ll have to meet certain income requirements to open one, says Slott. For single taxpayers, eligibility phases out when your income tops $114,000 in 2007. For married couples filing a joint tax return, the maximum eligibility limit is $166,000.
If you currently don’t qualify, look at the deductible IRA. It has no income requirements as long as you’re not enrolled in an employer-sponsored retirement plan. You get a deduction for your contribution and earnings grow tax-deferred, which means you pay income taxes when they’re cashed out. A nondeductible IRA lets earnings grow tax-deferred, too, and it’s open to anyone.
3. Maintain an aggressive asset allocation
It’s not just enough to save. You also need to keep an eye on existing retirement assets to ensure you’re not squandering opportunities for growth. Someone in his 30s needs to invest aggressively, allocating up to 80 percent or even 90 percent of assets to a diverse array of stocks, says Ellen Rinaldi, executive director of investment planning and research at Vanguard.
That’s the track Todd French is following. At 35, French already has much to show for his ingenuity and hard work. It wasn’t long ago that he was scraping by as a music major on a college scholarship. Back then, he couldn’t even afford to repair his cello, so he learned fix the instrument himself.
And that’s how his company, Stringworks, was born. The online music boutique manufactures high-end, moderately priced stringed instruments for rent or purchase. Business has soared, clearly; French’s latest passion is racing Porsche automobiles. He also works a second job, one he loves, as a cellist for the Los Angeles Opera. And he just invested in a software company. His willingness to plow money into a startup enterprise makes him, he admits, somewhat of a risk taker.
But bold is different than foolish. When French was realized the bulk of his fortune was tied up in Southern California condominiums and Stringworks, he decided to switch gears. “Now my focus for retirement is to vary my investments,” he says. “I was pretty heavily into real estate. At the time, in the early 2000s, it was the right thing to do, but I need to expand and not have my eggs in one basket.”
So French sold some property, reinvesting the profits into stocks since, historically, they’ve outperformed bonds. (On average, they’ve gained just over 10 percent annually, about twice the rate of bonds, according to Ibbotson Associates.) Sure, stocks are riskier but, French says, now is the time he feels can he afford to be aggressive. “I stay involved with where I want my money to be, but I don’t manage it because I don’t trust myself,” he says. “I feel I’d make decisions on an emotional basis.”
4. Keep company stock in check
Whether you’re an entrepreneur or a salaried employee, there’s much to be learned from French’s commitment to paying attention to his investments. Don’t fall into the trap of saving then forgetting about your assets. That includes paying attention to company stock, which all too often grows to become far too much of a given portfolio.
If your shares in the company have done well, they may now make up a big chunk of your retirement plan. In fact, company stock currently represents a full 22 percent of 401(k) assets on average. Shares in a single company also make up more than half of 401(k) balances for one out of five retirement plans, according to analysis by human resources consultancy Hewitt Associates.
That’s far too high. Talk to financial planners and they’ll generally agree that company stock, or any other single equity for that matter, should never exceed 10 percent of your portfolio. More than that and you put your retirement at great risk. “Your savings shouldn’t be determined by the health of a single company,” says Rinaldi.
5. Don’t let a better job derail your retirement plan
If you’ve been changing jobs, or are seeking possibilities elsewhere, don’t let your retirement fund take a hit. Too often, a rich opportunity has the effect of unsettling savings amassed to date. Most frequently, this happens when individuals opt to cash out a 401(k) instead of leaving it intact. According to Hewitt, 49 percent of workers in their 30s cash out of 401(k) plans when they leave jobs.
Problem is, if you do cash out before age 59½ you’ll almost always owe a 10 percent penalty on top of immediately having to pay income taxes on the withdrawal, which could be end up being as high as 35 percent — the highest current bracket. A smarter move is rolling over the 401(k) into an IRA, which you can then invest any way you want.
Bad timing is another pricey trap. That’s because most employer retirement benefits make you work a period of time before you become eligible for full benefits — known as “vesting.” For example, with a 401(k), you may be able to keep 20 percent of an employer’s contributions after a year, but you’ll have to work another year to get an additional 20 percent and so on until you are fully vested. Pensions are structured a bit differently, with benefits usually becoming available after five years of service.
The bottom line: If you’re about to pass a vesting milestone that will enable you to keep more, or all, of your employer’s retirement fund contributions and pension benefits, it may be well worth it to wait before you leave for greener pastures. Ditto for quitting to care for children.
6. Start preparing for college
Now it’s time to focus on other expenses. Those with little babies take note: It’s never too early to think about college. Bear in mind, though, that financial advisers strongly advise that retirement savings should be your first priority.
“I see people who, early on in their careers, shorted themselves on retirement savings because they were planing for a child’s college instead,” says Gail Cunningham, a counselor at Consumer Credit Counseling Service in Dallas, and whose clients include retirees struggling to keep up with debts. “But when you go to college, there are work-study programs, grants, loans. There are scholarships. There are no plans like this to help with retirement. I’m not saying forget about college, but don’t neglect retirement, either.”
If you are determined to help your kid pay for Harvard, start early. Like any other big-ticket expense, it’s easier to save a little bit over the long haul than trying to play catch-up when your kids are in high school.
The good news is that there are plenty of tax-advantaged programs designed to help families maximize their education savings. A state-sponsored 529 plan allows earnings to grow and be withdrawn tax-free if the money is spent on bona fide education expenses. What’s more, your state may let you claim a deduction for making deposits.
7. Protect your earnings with disability insurance
Finally, safeguard your financial future. If you’re hurt or injured and can’t work, disability insurance will replace up to 60 percent of lost income, but only for a period of time. Most employers offer short-term benefits up to a couple of months. But about half of all medium- to large-sized companies provide long-term benefits of up to five years, and sometimes even for your lifetime, according to America’s Health Insurance Plans, an industry group. Check to make sure you’re covered. If not, and you can afford to, consider buying disability insurance on your own.
It’s a similar story for life insurance. Many employers offer it. But if you’re out of a job, you lose coverage. If you are short on cash, pick a term life insurance policy, which will get the most coverage for the least amount possible and allow you to lock in low, level annual rates over the long haul.
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