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7 Tips for Saving for Retirement with a Late Start

Over 40 and Behind on Retirement Savings? Here are 7 Tips.

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After you opened your 40th birthday cards, you realized you should learn about retirement savings. You bought a retirement book or magazine, which said that - oops! - you should have started saving for retirement in your twenties.

Ah, darn. You didn't start saving for retirement early. Now what?

Here are a few pointers to guide you through saving for retirement if you're entering the game late.

#1: Play Catch Up

Let's assume you're 40 years old, with $0 retirement savings. At your age, you're legally allowed to save $17,000 per year in a 401k retirement fund. How far will that money go?

(Read this article to learn your retirement contribution limits.)

Assuming a 7 percent rate of return - which, not coincidentally, is the average annualized rate of return that investing legend Warren Buffet predicts we'll see in the coming decades - your 401k will grow to $1 million in 24 years and 2 months. That means you'll be on track to have $1 million by the age of 64, in time for retirement.

You'll need an extra 7 years to have an inflation-adjusted $1 million, equivalent to today's dollars. In other words, you'll have an inflation-adjusted $1 million by the age of 71, assuming you keep contributing $17,000 per year. Since many retirees work until the age of 68 or 70, working for an extra 7 years could be a feasible goal.

#2: Understand How Much You Need

"But I don't need a million!," you might be thinking. "I just want a simple life."

Ah, but a simple life requires $1 million in the bank. You see, most experts agree that during your retirement, you should withdraw no more than 3 - 4 percent of your retirement portfolio each year. (These are known as the "4 percent rule" and the "3 Percent Rule"- read both articles to learn the details.)

Three percent of $1 million is $30,000. Four percent of $1 million is $40,000. In other words, if you want to live on an income of $30,000 - $40,000 per year in retirement, you'll need a portfolio of at least $1 million dollars.

(This assumes that you don't have a pension, rental properties, or other sources of retirement income. It also excludes Social Security, which many people find to be more paltry than they expect.)

#3: DON'T Take on More Risk

Some people make the mistake of taking on additional investing risk to make up for lost time. The potential returns are higher: rather than 7 percent, there's a chance that your investments can grow 10 percent or 12 percent.

But the risk, the potential for loss, is also much higher. Your risk should always, always be aligned with your age. People in their twenties can accept greater losses, since they have more time to recover. People in their forties cannot.

Don't accept extra risk in your portfolio. Pick one of the following tried-and-true asset allocation recommendations:

  • 120 minus your age in stock funds, with the rest in bond funds. (Highest acceptable level of risk.)
  • 110 minus your age in stock funds, with the rest in bond funds. (Moderate level of risk.)
  • Your age in bond funds, with the rest in stock funds. (Most conservative acceptable level of risk.)

#4: Open a Roth IRA

Once you're finished maxing out your 401k, open an IRA and maximize your contribution to that, as well. A 40-year-old who is eligible to fully contribute to a Roth IRA can add an extra $5,000 per year to their retirement savings.

Contributions to a Roth IRA grow tax-free and can be withdrawn tax-free. You'll even avoid capital gains tax.

#5: Buy Adequate Insurance

Calamities are the single biggest reason that people are forced to declare bankruptcy. Reduce your risk by buying adequate health insurance, disability insurance and car insurance.

If you have dependents, consider term life insurance for the duration of the time that your dependents will rely on you financially. Many financial experts say that whole life insurance is generally not as good of an idea, especially if you're starting the policy in your 40's.

These are just general observations; talk to a fee-based financial planner to get personally-tailored advice. Look for planners who have a "fiduciary duty" to you, the client.

#6: Pay Down Debt

Pay off credit card debt, car loans, and other high-interest or non-mortgage debt.

Weigh whether or not you should make extra payments on your mortgage. If you're in the early stage of your mortgage, and many of your payments are being applied towards interest, it might make more sense to make extra mortgage payments. If, however, you're in the final years of your mortgage and your payments are primarily being applied to the principal, you may be better off investing that money.

#7: Remember: You and Your Spouse Come First

Don't skimp on retirement savings in order to send your children to college. Your kids have more options and opportunities than you do.

Your kids can take out student loans. You can't take a "retirement loan."

Your kids have their entire lives ahead of them. Time is on their side. Time is NOT on your side.

Your kids can start saving for retirement in their 20's and 30's. You cannot.

Your kids are adults now; let them stand on their own two feet. The best gift you can give them is your own financial retirement security.

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