Have you ever wondered what sets you apart from people who retire young?

All over the Internet, you can find incredible success stories of regular folks who were able to pull off the impossible.

But what is their secret?  How do you retire young in today’s world when so many of the odds seem stacked against you.

It’s one of my personal hobbies to read these stories and look through the details to see what makes them different.  And you want to know what I’ve noticed?

It’s not that they won the lottery or received a huge inheritance. It’s also not that they were necessarily big-time executives earning way more money than you and I.

No, the answer is actually much simpler than you might think.  Most of the early retirement success stories I’ve read have one theme in common: They all involved extremely high savings rates.

It’s true.  You can find this in nearly every case.  But just exactly how high of a savings rate are we talking about?  Let’s consult those who have actually retired young to find out.

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How Much Money Do You Need to Save to Retire Early?

So what is the right proportion of your savings to stash away if you want to kiss the cubicle goodbye?

Probably one of the oldest cited blog posts come from Jacob at Early Retirement Extreme.  In this article, he lays out a chart describing how many years each level of savings frees you:

• If you save 5% if your income, you can take 1 year off every time you work 19 years.
• If you save 50% of your income, you can take 1 year off every time you work 1 year.
• If you save 90% of your income, you can take 9 years off every time you work 1 year.

Is this actually true?  Check out these choice selections from some of the more popular early retirement blogs and see for yourself.

• Mr Money Mustache calculates it would take 10.9 years to retire if you saved 64% of your income.
• Mr and Mrs 1500 from the blog 1500 Days: “Right now, I think in our most efficient life, now that we’re not doing that, we save at least 75%. And our life isn’t compromised. We’re very happy. (From an interview on the Mad Fientist podcast).
• Jeremy from the blog Go Curry Cracker: Our overall savings rate started relatively low (albeit high by average American standards), but as income rose and we learned how to be more efficient with our spending, our savings rate passed 70%.
• Brandon from the Mad Fientist: My savings rate in 2014 averaged over 73% but I expect that number to be higher this year because my expenses have dropped dramatically.
• Frugalwoods from their blog Frugalwoods: Mr. Frugalwoods and I finally did the arithmetic on our 2014 savings and expenditures (as I’m sure you’re all relieved to know). While in any given month of 2014 we vacillated between saving 65%-82%, our average savings rate for all of 2014 is 71.4%. Woot!

Noticing the same trend as I am?

Yes! If you want to do something as extraordinary as retire early at a young age (like in your 30’s or 40’s), then you have to do something as extraordinary as reach a remarkably high savings rate!

But why is this the key?

How Does a High Savings Rate Help You to Retire Young?

One of the most interesting and often under-appreciated facts about achieving a high savings rate is the way in which it positively affects your whole financial freedom plan.

What do I mean by this?

To put it simply: When you’re putting more money away in your nest egg for retirement, you’re not just simply saving money. You’re also training yourself in the present to live / need less income. Therefore, your target nest egg amount in the future should decrease.

And guess what?

A higher savings rate + lower nest egg target = you reaching financial freedom that much quicker!

Just look at how the math plays out with these simple examples:

Scenario 1 – 10% savings rate

• You earn $50,000 per year and save 10% or $5,000 per year.
• This means you’ll need roughly $45,000 of retirement income per year, and should therefore save up a nest egg of $1,125,000.
• At this rate, it will take you approximately 42 years to reach this goal! Ouch!

Scenario 2 – 25% savings rate

• You earn $50,000 per year and save 25% or $12,500 per year.
• This means you’ll need roughly $37,500 of retirement income per year, and should therefore save up a nest egg of $937,000.
• At this rate, it will take you approximately 27 years to reach this goal. Getting better!

Scenario 3 – 50% savings rate

• You earn $50,000 per year and save 50% or $25,000 per year.
• This means you’ll need roughly $25,000 of retirement income per year, and should therefore save up a nest egg of $625,000.
• At this rate, it will take you approximately 15 years to reach this goal.

Starting to notice something?

As we move from Scenario 1 to 3, not only are you saving more money each year, you’re also reducing your ultimate savings goal. Together, these two aspects are accelerating you closer and closer to your goal of achieving financial freedom.

You might even think of this as the double-ended approach to early retirement.  You save now in the beginning, and it results in needing less in the end.  Double-impact for your efforts!

By the way – Want to know how we did those retirement calculations just now? It’s a lot easier than you think. Read our article How Much Do I Need to Save for Retirement? The Incredibly Simple Answer.

Why Can’t I Just Invest for Better Returns?

You might have looked at the previous example and said to yourself: Hey, I’m pretty smart! Why can’t I just pick a few winning stocks, double my money a few times, and then retire early?

The problem: Nearly NO ONE is ever successful at picking high yield returns – even stock brokers and hedge fund managers!

Yes, everyone at one time has heard a story from a friend or relative where they picked a “hot” stock and made a ton of cash. But what they usually leave out of the big picture is that this was probably a one-time event. Or, worse, that they lost money on ten other stock picks before finally picking a winner! Over time, it’s simply a losing strategy.

Mutual fund legend Jack Bogle, founder of the incredibly popular investment firm Vanguard, is famous for publicly declaring that “85 to 90 percent of fund managers fail to match their own benchmarks”. Instead, he advocates that the common investor would be better off purchasing shares of a simple index fund that merely tracks the overall market performance. (This idea has become so popular that it has a financial cult following of people called “Bogle-heads”.)

The take-away: You CAN’T control the market. You CAN’T beat the market. The best you can ever do with your investments is to simply match market returns.

Therefore, the only place YOU really have any control is the volume of money you invest; your savings rate.

How Can You Increase Your Savings Rate and Retire Early Too?

I think the message is pretty clear: If you want to be like these early retirement success stories and reach financial freedom as quickly as possible, then you need to boost your savings rate as much as possible.

Sounds simple enough …

But the hard question is “how do you do that exactly”?

Start With Creating an Early Retirement Plan

No one ever gets in their car or boards a plane to go on vacation with no destination in mind. Financial freedom at any age is no different!

If you want to retire early, then you’re going to need a plan. And if you want to retire at lot earlier than everyone else, than you’re really going to need a good plan!

The best place to start is with a free retirement planning tool like this one from Personal Capital.

The way it works is simple. After creating your profile and linking your outside retirement funds, it then takes your nest egg and estimates how long your money will last (best and worst case market returns). From there, you can tweak the variables to make improvements, increase security, and run different scenarios.

Bump Up That Savings Rate!

Once you’ve got a plan together, from here on out it’s game-on to optimize your savings rate!

Where should you start?

The biggest hitters will be to begin with the following places:

• Budget your money! These practical tips will be helpful.
• Get a better job.
• Fight off lifestyle inflation.
• Take advantage of tax-advantaged retirement savings like 401(k)’s and IRA’s.
• Also take advantage of other tax-advantaged savings tools like FSA’s, HSA’s, and 529 college savings.
• Saving thousands of dollars on travel.
• Refinancing your mortgage.
• Paying less for your vehicle.
• Getting a better insurance rate.
• And so many more …

Little by little, the more you work on each of these points, the more money you’ll have to stash away.  And that will get you closer and closer to your goal of becoming financially independent.

Who knows.  Maybe it will be your early retirement success story I read next!

Readers – What do you think is the best way to retire young?  How important do you believe the role of savings rate plays?  Are there other strategies that can be useful too?

Photo(s): Unsplash

The post What’s the Best Way to Retire Early? By Doing This One Important Thing appeared first on My Money Design.

If you’re wondering “Can I contribute to an IRA and a 401(k) this year?”, then you’ll be delighted to know that the answer is most likely: Yes.

For most middle income families, the good news is that both spouses can usually contribute to both types of retirement plans.

With a 401(k), eligibility is pretty straight-forward. Your employer will either offer one or they won’t. The employee generally just has to meet the employer’s requirements which might be being 21 years of age (or older) and having worked with the company for a minimum amount of time (such as one year).

IRAs, on the other hand, are accounts that you set up yourself. If you want to start one, you simply pick a reputable financial institution and apply. Its really no more difficult than opening a checking account.

The real question, however, is which type of IRA you will be eligible to open and whether or not it will benefit your tax situation in any way.

The IRS has several requirements about the contributions you can make which are mainly affected by your income level and tax filing status.

Despite the stipulations, having the ability to save your money in both an IRA and a 401(k) is an incredible way to build your nest egg. Every contribution you make is an opportunity to avoid paying taxes one way or another. Therefore, I encourage you to consider your options and take advantage of the one that best works for you.

In this post, we’ll take a look at the different types of IRAs and see what the rules are for being able to contribute to each one.

Three Types of IRA Contributions

Generally speaking, there are two main types of IRAs:

• Traditional – Taxes are deferred until you retire
• Roth – Taxes are paid up-front

You can learn a ton more about the differences between traditional and Roth IRAs in this post I wrote here.

Now, here’s where it can get a little confusing. For these two types of IRAs, there are actually three types of contributions you can make:

1. Deductible traditional
2. Non-deductible traditional
3. Roth

Here’s how each one is different.

Deductible Traditional IRA Contributions

A deductible contribution to a traditional IRA is what most people think of when they think about contributing to a traditional IRA.

Every time you make a contribution, it can be deducted from your taxable income for the year. That means you don’t pay any taxes on this savings up-front. Any tax payments on your contributions and the earnings you accumulate are delayed into the far-off future when you retire someday.

This is a great arrangement for anyone who thinks they will be in a lower tax bracket when they retire in the future.

Qualifications

For your contribution to qualify as tax-deductible, you need to meet 3 different criteria:

1. Tax filing status (single, married filing jointly / separately, etc.)
2. Your MAGI (stands for “modified adjusted gross income” and is generally calculated when you file your taxes)
3. If you or your spouse are covered by another retirement plan at work.

The full requirements for 2020 from the IRS website can be divided between whether or not you are covered by a retirement plan at work.

If you are covered by a plan at work:

If you are not covered by a plan at work:

More on this below when we talk about non-deductible traditional IRA contributions.

Roth IRA Contributions

Contributions to a Roth IRA are a little less complex when compared to a traditional IRA.

By design, Roth IRA contributions are not tax-deductible at the time that you make them. You pay taxes on them up-front and receive no tax benefit when you file your income taxes.

However, these contributions plus any earnings you accumulate will grow tax-free. Even when you someday retire, both the contributions and earnings can be withdrawn without any tax payment due. (The opposite of a traditional IRA.)

This can be a great strategy for anyone who believes they will be in a higher tax bracket when they retire in the future.

Qualifications

In order to make a contribution to a Roth IRA, you only need to meet 2 criteria:

1. Tax filing status
2. Your MAGI

You don’t have to worry about if you or your spouse are covered by another retirement plan at work.

For your MAGI, note that as you earn more money, the IRS will begin to reduce how much you can contribute to a Roth IRA. You’ll be able to make what’s known as a partial contribution. As your income increases, your elidgibility may phase out altogether.

Here are the full requirements for 2020 from the IRS website:

Non-Deductible Traditional IRA Contribution

If it so happens that you earn too much money to be able to contribute to both a deductible traditional IRA and a Roth IRA, then there is still one more option for you to consider: A non-deductible traditional IRA.

Technically, you are always allowed to make a non-deductible contribution to a traditional IRA. There are no income restrictions.

However, with non-deductible contributions, you do NOT get to deduct the contribution from your taxable income for the year. That means you will pay taxes up-front on this savings, but not when you retire. (… Almost like a Roth IRA.)

Then, here’s where things get different. The earnings you make off these savings are tax-deferred and delayed into the far-off future when you retire someday. (… Not the same as a Roth IRA.)

Why make a non-deductible IRA contribution?

Even if you can’t benefit from deferring taxes on your contributions, its still an advantage to defer them on the earnings you will make.

Generally, if you were to take your after-tax money and invest it in some mutual funds, at the end of the year you’d owe taxes on any earnings you’ve accumulated due to capital gains, interest, dividends, etc.

But if you invest this money inside an IRA (even if non-deductible), then you get to defer these taxes. That means your earnings will effectively grow tax-free until you withdraw them someday for retirement.

Deductible vs Non-Deductible Traditional IRA Examples

Because the eligibility requirements for traditional IRAs can be a little confusing, it might be helpful to go through a few examples to illustrate when your contribution can be tax-deductible:

Example 1:

• If you are single and your MAGI was $50,000 AND:
• You are covered by a retirement plan at work = Full deduction of your contribution.
• You are NOT covered by a retirement plan at work = Full deduction of your contribution.

Example 2:

• If you are single and your MAGI was $100,000 AND:
• You are covered by a retirement plan at work = No deduction.
• You are NOT covered by a retirement plan at work = Full deduction of your contribution.

Example 3:

• If you are married filing jointly and your MAGI was $100,000 AND:
• You are covered by a retirement plan at work = Full deduction of your contribution.
• You are NOT covered by a retirement plan at work but your spouse IS = Partial deduction of your contribution.
• You and your spouse are NOT covered by a retirement plan at work = Full deduction of your contribution.

Example 4:

• If you are married filing jointly and your MAGI was $200,000 AND:
• You are covered by a retirement plan at work = No deduction.
• You are NOT covered by a retirement plan at work but your spouse IS = no deduction.
• You and your spouse are NOT covered by a retirement plan at work = full deduction of your contribution.

Roth IRAs and High-Income Earners

If you’re really stuck on the idea of contributing to a Roth IRA, BUT you earn too much money to be eligible, don’t worry. There’s still a way you can do this …

You’ll need to use a technique called a back-door Roth IRA conversion. In a nutshell, what you’ll do is:

1. Make a non-deductible contribution to your traditional IRA.
2. Contact your financial institution and ask them to convert the funds over to a Roth using IRS tax Form 8606.

Pretty simple! You can find out a lot more about Back-Door Roth IRA conversions at this article I wrote here.

Backdoor Roth IRA conversions can be pretty useful, especially if you’re someone who plans to retire early like me. By converting your savings from a traditional to a Roth style account, you’ll be able to access this money and use it without having to pay the penalty for withdrawals before age 59-1/2.

IRA Contributions Later in Life

If you happen to still be working in your 70’s and would like to keep making contributions to your IRA’s, then there are a few things you’ll need to know.

Unfortunately, you’ll no longer be able to make any contributions to a traditional IRA. This is because by the time you are age 72, the IRS will start to require you to start making something called RMD’s (required minimum distributions). Effectively, the IRS makes you start taking money out of your IRA, or you will face a staggering 50% penalty! As you might guess, its because the IRS has allowed you to defer taxes for long enough and wants to start collecting those taxes you owe on these savings!

Since there are no RMD’s on Roth IRA contributions, you are allowed to keep contributing to one if you wish.

Get Your Full 401(k) Employer Match

While it’s awesome that you want to contribute to both your 401(k) and your IRA, you may want to prioritize one over the other first in order to maximize your money.

Generally speaking, most people should contribute in the following order:

1. Contribute as much as needed to your 401(k) to get your full employer match. This number will differ for each person.
2. Contribute up to the maximum amount of your IRA.
3. Go back to your 401(k) and contribute to it until you’ve reached the IRS max.

You can find out a lot more about these steps in detail at this article I wrote here.

What If I Have a Roth 401(k)?

If your employer offers a Roth 401(k) plan in addition to a traditional 401(k) plan, and you’ve decided to use it, then it changes nothing. All of the same rules we’ve gone through above will still apply.

Photo credits: Unsplash

The post Can I Contribute to Both an IRA and a 401(k)? appeared first on My Money Design.

So you want to save for retirement, and you’ve heard good things about both 401(k)’s and IRA’s.

You’d love to save your money into both types of retirement accounts. But unfortunately, that might not be possible.

First, there’s the big question: Are you even eligible? Maybe you work at a place that doesn’t offer a 401(k) plan. Or maybe you have no idea if you qualify to open an IRA.

Next, if your finances are anything like most American households, then there’s only so much money to go around. Your paycheck is only so big, and you might only be saving somewhere around 10 percent of it. There might be enough to spread around.

Finally, there’s the debate of what’s best for you and your money. Do any amount of searches in Google for IRA vs 401(k) plans, and you’ll soon find that the jury is always out. Some people absolutely love IRA’s over 401(k)’s, while other people will fight tooth and nail to convince you that the opposite is true.

With so many differences of opinions, who’s right and who’s wrong? And what are you supposed to believe?

In this post, we’re going to skip past all the boring, recycled facts about retirement planning and get straight to the point of addressing the big question: Should I put money in a 401(k) or IRA first?

By the end, you’ll have a better understanding of what questions you need to first ask yourself, and how your answers will shape which plan is truly the best place for you to save your money.

First Thing to Know – Either is a Good Choice

Before anything else, let’s address the first question regarding eligibility for the retirement plans.

It will be helpful for you to know that it’s very common for most middle-class Americans to be able to save their money in both an IRA and 401(k). Generally for:

• A 401(k) plan, your employer simply has to offer one.
• An IRA, you get set this up yourself with any major financial service provider (and is no harder to do than setting up a regular bank account).

To be sure if you qualify due to your income level or employment status, you can check the IRS requirements at this link here.

Above all else, both a 401(k) and IRA are a great choices for your retirement savings over traditional bank accounts because they offer the unique advantage of tax-deferment.

Remember that when you save your money in a regular bank account, it’s with AFTER-tax income from your paycheck, meaning that you’ve already paid taxes on this money.  On the other hand, with retirement accounts, you make your contribution BEFORE the taxes are taken out.

Why does that matter?  Let’s say you have the choice to save $10,000 of earnings this year.  By the time you receive that money in your paycheck, it will be approximately $7,500 because $2,500 went to taxes.  But with your retirement accounts, you get to stash the whole $10,000.  That’s a huge 33% difference!

So given the choice between the two retirement plans, where’s the best place to start?

1- 401(k) Employer Matching Contributions

The first question to ask yourself is whether or not your employer offers you any sort of 401(k) matching contribution.  This is money that your employer kicks-in to your 401(k) alongside your contributions.

If your employer does this, start saving your money inside your 401(k) and do everything you can to maximize it!

Seriously.  Passing up employer contributions is like leaving free money on the table.  It’s just plain foolish.  I’m sure if your boss was walking around passing out $100 bills, you wouldn’t pass that up.  So why pass up the chance to collect the same thing using your 401(k)?

According to Investopedia, on average, most employers will match anywhere between 50 cents and $1 for every $1 you contribute to your 401(k) (up to some pre-set maximum amount).

Wow!  A dollar for dollar match?  You’d be effectively doubling your money for doing nothing more than simply choosing to save it.

Also not to mention that, just like your contributions, this money grows tax-deferred until someday in the future when you withdraw it for retirement.  Good deal!

Unfortunately for the IRA, since this is your personal plan, it is extremely rare for employers to help in any way with contributing to it.

Bottom line: If you’re employer offers 401(k) matching, you’re definitely going to want to start contributing to the 401(k) plan. Contribute as much as you need to in order to get the full matching benefit!

2- Fees and Flexibility

Following employer matching contributions, the next point to consider on using a 401(k) or IRA first is that of fees and flexibility.  And in this debate, usually the IRA wins.

Because you can choose which investment company to start your IRA, you’re going to find a lot less expensive options than probably what your 401(k) will offer.

For example: My go-to for investing is Vanguard.  They offer lots of fund choices that carry an annual expense ratio of 0.25%.  In fact, they’ve got a very popular stock market index fund that costs only 0.04% per year.  This means you’re paying $4 for every $10,000 you’ve got invested.  That’s almost nothing!

By contrast, the average 401(k) fund carries an annual expense of 1.0% according to the Center for American Progress.  That’s more like $100 for every $10,000 you’ve got invested.  Which would you rather pay?

Combine this with the fact that IRA’s don’t have any administrative fees.  401(k) plans do.  Most people don’t realize it, but they’re actually also paying an additional fee to their plan administrator to simply “run” the 401(k).  CNBC found that depending on the size of your company’s plan, this could be an extra 0.27 – 1.13% annual expense.

Also because you get to choose who your IRA is through, this gives you an added benefit of choosing among thousands of options.  With a 401(k), most of the time your plan is limited to only the choices that your plan administrator will allow.  If you don’t like those options, then you’re generally out of luck.

Finally, with IRA’s, you have a little bit more flexibility over the fund.  With 401(k)’s, you have to ask for your plan administrator’s permission to take out loans or file for special withdrawals.  With an IRA, since you are the boss, you make these decisions with your investment service provider.

Bottom line: After contributing as much as you need to get your full 401(k) employer match, route the remainder of your savings into your IRA.

3- How Much Do You Plan to Contribute?

After fees, the next topic to consider is how much money you plan to save every year.

For most people only saving about 10 percent of the median Amercian income of approximxatley $60,000, this works out to $6,000 per year. So points 1 and 2 above are enough to take care of this.

But what if you earn more money than that, and therefore have more money to go around?

What if you’re a super saver, and you go above and beyond your peers by saving 25% or even 50% of your income in an effort to hit those financial freedom goals much sooner?

This is where the IRA’ will fall short. Although it’s great for flexibility and usually lower in fees, the maximum amount you can contribute is quite a bit less than your employer plan.

As of 2020, the maximum annual contribution you can make to an IRA is $6,000. That’s not nearly as much as the $19,500 you’re allowed to stash away in your 401(k). Even if you plan to put money in both your IRA and your spouse’s IRA, that’s still only $12,000 altogether.

Plus, remember the first thing we said: Both plans are good because they offer tax-deferment. Regular brokerage and savings accounts with after-tax money can’t do that.

Therefore, you’re going to want to go back to your 401(k) and start increasing your contribution levels.

Bottom line: After you’ve maxed out your IRA, you should then switch back over to your 401(k) and continue to save your money there.

Do I Use a Roth or Not?

One more ingredient to make this subject just a little bit more complicated is the issue of whether or not to use a Roth-style account.

As you might already know, Roth accounts are the opposite of Traditional-style accounts.  With a Roth, you pay your taxes now, the money grows tax-free, and then remains tax-free even after you’ve retired.

To Roth or not comes down to one simple question: Do you think you’ll have more expenses now or in the future?

What is this question getting at?  It’s trying to identify whether you think you’ll be in a higher tax bracket now or later.

If you think you’ll have fewer expenses at retirement, then this means you’ll likely need less money, be in a lower tax bracket, and therefore the Traditional style account would be better suited for you.

But if you plan to live more luxuriously, travel, or just plain enjoy your money more in retirement, then chances are you’ll be in a higher tax bracket and the Roth makes more sense.

To find out more about the differences between Roth and Traditional style accounts, check out our full guide here.

Maximize Your Savings

Again: The best-case scenario when it building up your nest egg, you’re going to want to max out your retirement savings accounts as much as possible!

When you do this, it accomplishes every one of the goals we’ve discussed so far:

• Minimizing your taxes as much as possible, which translates to more money in your pocket.
• Maximum employer contributions.
• Tax-deferred or tax-free growth.

If you’re looking for some practical tips on how you can start saving more your hard-earned income, then please check out my book Save MORE, Earn MORE.  Here you’ll find some proven strategies for stashing more of your money every year.

Readers – Where do you recommend to your friends that they put their money first – a 401(k) or IRA?  What order or strategy do you like to use to get the most out of each one?

Photo credit: Pixabay

The post Should I Put Money in a 401(k) or IRA First? appeared first on My Money Design.

After reading enough personal finance blogs, this whole financial independence thing starts to sound pretty good!  But what exactly are the steps to retire early?

How does someone acquire enough money to never have to work again (if they choose)?

What was the path that got them there?

And more importantly, what are the habits and routines in our daily lives that we can adopt that will help make early retirement an option?

You might be surprised to learn that much of achieving financial independence has less to do with earning a lot of money and more to do with how you go about getting it.

Your ticket to freedom doesn’t necessarily have to include some fancy high-paid position.  Although it might help accelerate things a bit, the steps to retire early are fundamentally the same whether you earn $50,000 or $500,000.

What it should include is discipline and the ambition to squirrel your money away in all the right places.

In this post, we’ll organize each of these tips into 10 steps that will give you the most bang for your buck.

1- Make Your Financial Education a Priority

I’m always amazed at how much the average person can tell you about their favorite sports team or beer.  But then it comes to knowing the difference between a 401(k) or IRA, they have no clue.

The path to early retirement isn’t something that happens causally.  In order to properly plan the right strategies and then know how to execute them, you need to become a bit of a black-belt in personal finance.  And that means putting forth some effort in your own financial education.

The best place to start is to read at least one good book about how to manage money.  In particular when it comes to the topic of early retirement, one that I really enjoyed was “How to Retire Early” by Robert and Robin Charlton.  It’s the story of how a couple was able to retire in their early 40’s after going from basically nothing to one million dollars of savings in just 15 years!

Of course, if you’re just getting started, our “Start Here” page on this blog can also be great place to find a ton of organized information.

2- Know Your Savings Target

No one ever just gets on a plane and flies somewhere random.  They have a destination; a place they intend to go to.

The same is true of retirement.  And when going after early retirement, it’s extremely important.

The easiest way to figure out your retirement savings goal is to start with the 4 Percent Rule.  This would be the amount of money that you pull out of your savings every year to live off of passively.  To figure out your savings goal, simply divide your desired income by 0.04 or multiply it by 25 (mathematically its the same thing).

Example: I want to retire on $5,000 per month.  That’s $60,000 per year.  Therefore, to find my nest egg savings target, I multiply $60,000 x 25 = $1,500,000.

If you want to retire younger than 50, then I’d suggest you replace 4.0% with 3.5%.  (Or you can multiply your target income by 29 instead of 25.)  The reason is because the younger you retire, the longer you will need your money to last.  So by starting with a lower withdrawal rate, you’ll increase your chances for success.

3- Start Saving Yesterday

Okay … obviously you can’t do that.  But hear this …

There’s an old saying that goes: The best time to plant a tree was 20 years ago.  The second best time is right now.

In terms of personal finance, this is talking about the power of compounding returns.  Leveraging “time” to let your investments grow is one of the most effective tools that any saver has.

It can lead to returns that FAR surpass anything they could have saved on their own.  If you don’t think so, just look at this graph here.

So even though you can’t go back in time and start saving, make no excuses for today.  Start putting away as much as you can, and keep doing it regularly.  As your returns start to stack up and grow, you’ll be glad you did.

4- Simplify Your Investing With Funds

Forget trying to chase after high yields.  Forget complex asset allocations.  This is a fools’ game.

When it comes to knowing the best funds to pick, stick to the index funds.

In case you don’t know what those are, an index fund is an investment that simply tracks the market.  Basically, you always earn whatever the average market has earned; no more and no less.  While that might not sound very sexy, over time this strategy has proven to be incredibly effective – especially for newbie investors!

In terms of diversification, some financial experts recommend as few as two types of index funds: One for large-cap stocks and one for bonds.  While you’re in the saving phase of your progress, invest heavily into the stock index fund.  Even though it will be more violate than the bond fund, it will provide you with the greatest chance of success over the long run.  If you’d like to see for yourself, just check out the S&P 500 returns over the past few decades.

5- Save As Much As Possible Every Year

Again: Scrap the idea of trying to chase after some stock or fund that’s promising higher returns.

Believe it or not, the biggest part of your retirement plan that you have complete control over is how much you choose to save.  And therefore, you should do everything in your power to put away as much as you can afford.

Think about it this way: Instead of taking an unnecessary risk to try to get an extra 1-2% return, why not just find a way to simply save another $1,000 or $2,000 this year?  That way, you’re guaranteed to increase your savings by that much.

And the more money you save, the more volume those compounding returns have to work with towards producing bigger returns.

6- Take Full Advantage of Tax-Advantaged Savings Plans

If you’re putting your savings into the bank or a regular brokerage account, you’re doing yourself a great disservice.

A 401(k) or IRA is far superior to regular taxable accounts for one big reason: tax-deferment.  Your ability to save your money before taxes are taken out gives you a 33% edge over regular systems of saving.

Consider the math: Normally $1 earned is really about $0.75 net to you after 25% taxes.  But when you use a tax-deferred savings plan, the whole $1 is saved.  That’s $1 / $0.75 = 1.33 = 33% more!

On top of this, tax-advantaged savings plans also shield you from having to pay taxes on your earnings every year when you move funds around or receive dividends.  That’s just more savings for you!

7- Get All the Free Money You Can

Tax-advantaged savings plans aren’t the only break the IRS gives you.  Make sure you also take advantage of these awesome perks too:

• Most employers will make matching contributions to your 401(k) plan; sometimes dollar for dollar. That would be the easiest way ever to get a 100% return on your money – tax deferred too!  Find out what your employer offers and then do everything you can in your power to take advantage of the full match.
• Flexible savings plans are a way for the employees to get a similar tax break on medical expenses and dependent care expenses. If your employer doesn’t offer them and you have high medical deductibles, you might be able to qualify for an HSA
• 529 plans are very similar to IRA plans but with the purpose of saving for your child’s college expenses instead of your retirement. Tax breaks while saving for your children’s future means more savings available to you to put towards your own retirement.

8- Learn to Live on Less

If you’ve ever calculated how much money you thought you needed in your nest egg to retire early and said to yourself: How will I ever save up that much?

The answer is that you might not need to.

Retirement planning is a double-ended approach.  On the back side, you save up a bunch of money towards a nest egg goal that you hope to have in the future.

But on the front side, you can learn to discipline your lifestyle and not need as much as you might think.  This will in turn lower how much money you’ll need in retirement, and thus lower your nest egg target goal overall!

This is actually how many early retirement bloggers have accomplished their goals at such a young age.  The classic example is of Mr. Money Mustache who got his annual expenses down to $24,000 per year.  Therefore, he only needed $600,000 to retire by age 30.  If you want more, here are four other examples.

While your numbers will likely be different (I know mine are), the equation still works out the same.  Practice some moderation in your spending, and early retirement will be closer than you think.  Here are some useful strategies for stretching your budget.

9- Challenge All Purchases

There was a time when I cringed at the word “frugal”.  Mostly because I associated it with “no fun”.

But now frugal means something different to me.  It means: Getting exactly what you want at the lowest price.  Not holding off on making the purchase.  Not skimping on quality.  Buying exactly the thing I wanted for the absolute best price.

I consider it to almost be like a fun sport!  How low can I get the price?

When my wife and I wanted a new SUV, we didn’t just go out and buy the first one we test drove.  There was a fair amount of research that went into it before ever set foot at a dealership.  But even then, we walked away from several who were not willing to be flexible on price or give us a fair trade-in for our old vehicle.  But make no mistake – we eventually found the right sellers and ended up getting the SUV we wanted at a great price!

Start doing this with your major purchases, and you’ll see the difference.  I’ve been pleasantly surprised by how little effort it takes to knock 10%, 20% or sometimes even 50% off the price I thought I was going to pay for something I wanted or needed.   And all that does is keep more money in my pocket!

10- Ignore the Noise

I’m going to circle back to my first tip to invest in your financial education because when it come to your money, there’s going to be a TON of noise out there trying to distract you.

There will be people that tell you everything from you’re doing it all wrong to you’re missing out on a great investment opportunity!

It’s all nonsense.  The number one rule to money is to stick to what you understand.  If anyone comes along promising you something that either doesn’t make sense or simply sounds too good to be true, it probably is.

Make no mistake – this happens to both smart and uneducated people alike.  How do you think someone like the infamous Bernie Madoff was able to swindle so many affluent millionaires of billions of dollars with his Ponzi Scheme?  The problem is that people allowed themselves to make decisions based on greed rather than using common sense.

Again, don’t listen to the noise.  Make your plan, keep it simple, and stick to it.  As I usually say: No one should care more about your money than you.

Readers – What steps to retire early can you recommend?  What habits or tricks have you found to be the most effective (or ineffective)?  What helps keep you on the path to financial independence?

Featured image courtesy of MMD, taken on the beach of Los Cabos Mexico

The post 10 Steps to Retire Early – What You Should Be Doing Right Now! appeared first on My Money Design.

Do you pay taxes on the money you earn from your side hustle? If so, then he’s a hack you’ll want to know: Contributing to a SEP IRA can help lower your taxes as well as allow you to stash away more money for retirement!

For years I’ve enjoyed making money on the side from blogging.  But in the eyes of the government, that money is “business income”, and therefore taxable.  So while it was fun to earn several thousand dollars per year, it wasn’t so great having to pay roughly a quarter of that money back into taxes every year.

Just like all the steps I’ve taken to reduce my personal taxes down as much as possible, I knew there had to be a way to do the same with my business income.

That’s when I discovered the SEP IRA. By maxing out your SEP IRA contribution each year, you can offset your taxable business income and save roughly one-fourth of what you would normally owe in taxes.

At its peak, that’s been a reduction much as $1,000 in the amount of taxes I owed for the year.  But over time, these savings can really start to add up!  Perhaps into the tens of thousands of dollars!

If that wasn’t great enough, the benefits don’t stop there!  If you’re also in the unique situation where you’re already maxing out your 401(k) and IRA, then a SEP IRA can also be your tool to save even more money for retirement tax-deferred.

Yes, I get to contribute to all three accounts!  By doing so, I get to maximize my efforts towards reaching financial freedom and put the power of compounding returns to work making money for me!

If you’re a money-making blogger or even someone with a hobby that earns them some extra income on the side, then you’ll definitely want to know how contributing to a SEP IRA could benefit your retirement savings as well as lower your taxable income. Read on to see what a SEP IRA is exactly, how it’s different from the other types of IRA’s, and how it could be used to potentially save yourself thousands of dollars in taxes this year!

What is a SEP IRA?

Chances are that unless you’re self-employed (or really into personal finance strategies like I am), than you’ve probably never heard of a SEP IRA.

A SEP IRA is short for a “Simplified Employee Pension Individual Retirement Arrangement”.  Basically it’s another style of retirement plan designed for people who are either work for themselves or have a very small number of employees.

Keep in mind: You can be both employed by someone else AND self-employed.  My situation is a good example of this.  I earn a regular salary from my day-job and from blogging.  Therefore I am both.

Without getting carried away on the technicalities, you can think of a SEP as the same thing as a regular traditional IRA.  They carry the same rules for deductions, tax-sheltered investment growth, investment options, and no early withdrawals until age 59-1/2.  However, there’s one BIG difference to note: You get to contribute to a SEP IRA as two different people, 1) the employee and 2) the employer.

The employee part. 

Contributing to your SEP IRA as an employee is really no different than when you contribute to your regular IRA.  You can invest up to $6,000 for the year in ANY combination of the IRA’s you choose.

Example: If you wanted to put $4,000 in a Roth IRA and $2,000 in a SEP IRA (as an employee), you could do so.  Since I already max out my Roth IRA every year, my SEP IRA employee portion is $0.

The employer part. 

Now here’s where it starts to get interesting!

Because you’re declaring business income (from your blog, freelancing, whatever) on your tax filing, the government treats you like you’re self-employed (again, even if you’re also a full-time employee for someone else).

Therefore, as your own employer in this regard, the IRS says that you have the opportunity to pay yourself a nice big bonus to put towards your retirement savings.

How much exactly?  Employer SEP IRA contributions can’t go over the lesser of:

• 25% of the employee’s total compensation.  (Note: If you’re like me, the actual math works out to 20% of your Adjusted Profits.  I’ll show you can easily calculate this yourself in the section below.)
• $57,000 for the 2020 tax year.

How This Ends Up Saving You Money in Taxes

If you’ve been questioning up until now how this is all supposed to benefit you, here is the part you were waiting for: Your SEP IRA employer contributions are deductible as a business expense.

Basically that’s like saying if you made $20,000 last year, you could choose to pay taxes on the whole $20,000 OR you could give yourself $4,000 for retirement and only pay taxes on the remaining $16,000.

Which one would you rather do: Pay the government or keep more of your hard-earned money for yourself?

I know which one I prefer …

Just in case you’re feeling curious, here’s an example of how to actually calculate how much you could stash in a SEP IRA according to how the IRS calculates it.  Fidelity has a good worksheet that helps guide you through the steps that you can download here.

Example:

Suppose your profits for the year were $20,000 after you subtract away Self-Employment Tax.

Take $20,000 divided by 1.25 = $16,000.

Then take $16,000 x 0.25 = $4,000.

There you have it!  $4,000 is what you get to contribute to your SEP IRA for the year.

(Mathematically this also works if you simply go $20,000 x 20% = $4,000.  But who am I to argue with the way the IRS does things?)

If you’re in the 25% tax bracket, that’s $4,000 x 0.25 = $1,000 you just saved in taxes!

My Vanguard SEP IRA

I think anyone that reads this blog knows that I always prefer to deal with Vanguard over pretty much everyone else.  However when it comes to my SEP IRA, they go ahead and get some extra credit.

It was actually a phone call with Vanguard’s customer service where I first learned about my eligibility to contribute to one.  Not only did they explain how one works and the rules for contributing to one, they also let me know that the account is completely free of administration costs.

Again this year I’m happy to make another big contribution to my Vanguard SEP IRA and watch it grow even further.  I invest very simply using my favorite low-cost, balanced fund Wellington.  If you’re not familiar with this one, it’s a fund that contains about 65% stocks and 35% bonds.  The long-term annualized return rate is 8.33% which is pretty great in my opinion.  You get the added stability of bonds in your portfolio for almost no compromise in returns when you compare this to a 100% stock market index fund.

Hypothetically if someone were to contribute approximately $4,000 each year over the next 10 years into their SEP IRA investing in this fund, their balance would grow to over $70,000!  I don’t know about you, but that’s money I’d gladly accept on my path to financial freedom!

Readers – Do you have a SEP IRA or some other type of self-employment retirement savings account?  What are some other tricks like this that people should know about to help save themselves thousands of dollars in taxes for the year?

Photo credits: Unsplash, Pexels

The post How We’ve Saved $1,000’s in Taxes By Contributing to Our SEP IRA appeared first on My Money Design.

Admit it … You’ve probably asked yourself “How do I become a millionaire?” more than once in your life.

Don’t be shy! I can certainly tell you that I have. With all the images of happiness and security we see associated with wealth, how could you (or most anyone) not wonder about such a thing.

Regardless of what your actual financial goals are, the act of having a net worth of one million dollars or more is still heavily regarded as quite an accomplishment! In fact, in a survey conducted by investment service Charles Schwab, less than 10% of Americans had accumulated a net worth of $1 to $5 million.

So while 10% may sound like a small sliver of the population, keep in mind that this represents 9.4 million individuals.

Is there any reason you couldn’t become one of them? Of course you could!

Most of these people are not at all what you’d expect. In the book “The Millionaire Next Door”, the illusion that a millionaire is always some type of power-seeking, high-ranking executive is dismissed. The reality is that most of the people who have reached millionaire status are simply working-class couples who used a few simple, yet effective strategies to save their way to this goal!

What kind of strategies do I mean? Again, they won’t include day-trading stocks or buying a power-suit for your big move to Wall Street.

Instead, in this post, we’ll cover how ordinary people like you and I use simple savings and investing habits to build our own personal fortunes.  So with that said, let’s learn about what it takes to become a millionaire!

Leveraging the Power of Compounding Returns

Despite what you may think about how to become a millionaire, the path to getting there starts with leveraging one of the simplest assets we all have: Time.

That’s right. Your first step to accumulating your first million dollars (and beyond) starts with understanding how time can be one of your most powerful tools.

The secret comes in using something called compounding returns.  Compounding returns are the money that builds on top of the money you earn year after year.

To keep these two parts straight, let’s call:

• Your money = principal
• The money that grows on top = earnings

You can find a whole article I wrote on how compounding returns work here.

As the name implies, this combination of your principal savings plus the earnings will “compound”.

In the beginning when you first start to invest, your earnings won’t feel like very much. But over the years, as you accumulate more and more money, the earnings will grow in size as the volume of your fortune increases year after year.

Eventually, the earnings becomes so great that you’re actually making more money off of the earnings than you are from your initial principal investments.

Consider the following examples:

• An investment account with $10,000 earning will 10% will increase by $1,000 for the year.
• An investment account with $500,000 earning will 10% will increase by $50,000 for the year.

Quite a difference, right?

How Compounding Returns Make You Rich!

To give some idea of how powerful the effects of compounding returns can be, check out this post I wrote about encouraging your children to start a Roth IRA as a teenager.

In this example, an initial savings of just $16,500 as a teenager would have had the potential to grow into nearly one million dollars by the time that person was 60 years old.

Look at that graph for a minute. The blue bars are what the teenager contributed in the first few years. The green bars are the earnings that grew on top of the contributions.

In the first 10-15 years, it doesn’t look like he’s earning that much money. But you have to remember that when money “compounds”, it grows on top of the existing money; meaning both your contributions and your earnings.

Therefore, as time goes on, there will be more volume of money to generate more earnings. This is why after about 15 years the green bars start to overtake the blue bars. Essentially, he’s making more money from his earnings than he is from his initial contributions.

And this only becomes more evident as time goes on. By the time he’s in his 50’s, the earnings are growing at an exponential rate!

By the way: If you’ve got some numbers of your own you’d like to experiment with? You can try them yourself using this simple, free online compound interest calculator from BankRate.

The bottom line: 

If you want to reach millionaire status someday, you need to put compounding returns to work.  Its how you will be able to grow your savings above and beyond what you could ever save under your mattress. The more you save, the earlier you start, and more time you give it, the better it will be!

What Should I Invest In To Become a Millionaire?

Okay … so if using compounding returns is REALLY so simple, then why aren’t more people millionaires?

Because in order for compounding returns to be truly effective, there needs to be a reasonably high rate of return on your investment. And its finding such an investment where people can get themselves into trouble if they head down the wrong the path.

Recall that an investment can literally be anything:

• A savings account,
• Bank CD’s,
• Mutual funds,
• Stocks,
• … hedge funds,
• … whatever!

Unfortunately, relatively “safe” investments like savings accounts and CD’s don’t pay very exciting interest rates. At the 2-percent or so that I last saw online savings accounts and CD’s advertised, its going to take you a VERY long time before you’ll ever see a million dollars.

To accelerate the “becoming a millionaire” process, we’re going to need an investment that pays a bit higher.  We’re talking in the 5 to 10% range.

This is where the financial investment industry swoops in and is ready to help (read: take) your money. They will offer to manage your wealth and set you up with the “right” investments … all for a pretty-price. (I guess that’s how you become a $133 billion dollar industry.)

So what should you invest in? In order to build towards becoming a millionaire faster, what’s something you can manage yourself and still get a reasonably high rate of return?

The answer: stocks.

Why You Want to Invest in Stocks

Don’t freak out. Remember, I already told you that you’re not going to have to become a day-trader.  Nor am I going to have you analyzing any zig-zagging charts or reading the Wall Street Journal.

Another one of the big secrets of investing is that the most effective way to capture the power of the entire stock market is to invest in a large cap stock index fund such as the S&P 500.

Stock market indexes such as this have been proven over and over again to be very effective for everyone from beginner to advanced investors.  To illustrate this point, investment guru and billionaire Warren Buffett famously bet that an index fund would beat hedge fund managers after 10 years.  Turns out he was correct!

Over the long haul, stock market index funds produce returns of roughly 8 to 10% interest every year. To see for yourself, just check out the past performance stats on their Wikipedia page.

Where could you find an index fund?

Almost every major financial service provider has their version of the S&P 500 index fund. Here are a few to look into:

• Vanguard 500 Index Fund Admiral Shares (VFIAX)
• Fidelity 500 Index Fund – Premium Class (FXAIX)

Another bonus: Stock market index funds are also generally some of the cheapest funds you can buy. Whereas most managed funds charge expense ratios of something like 1%, the Vanguard fund only charges 0.04%. This means you’re literally paying $4 for every $10,000 invested.

Could you go for an even higher rate of return?

Of course you could. There are other indexes and individual stocks out there that have produced greater year over year returns. But as you can probably guess, they also have a greater potential to LOSE money. Depending on your timetable for wealth building, taking such a risk may not be something you want to do.

How to Get One Million Dollars Quickly

After reading that last section, you might ask yourself: Who wants to wait 40+ years to reach millionaire status?

And I get it. You probably want to reach this goal as soon as possible.

If that sounds like you, then there’s a very simple solution to this: Save more!

Each dollar you save has the same compounding potential as the next. Therefore, it should make sense that the more volume of money you save, the more quickly you’ll reach millionaire status.

To illustrate this point, look at what happens when you save all the way up to the U.S. IRS 401(k) maximum limit of $19,500 per year (starting in 2020). Save and invest this much each year into a stock market index fund, and you’ll have the potential to reach the million-dollar mark in just under 19 years.

Do you have a spouse who also works?  

If both of you can stash away your paycheck and save up to the max, then you’re effectively doubling down on the savings. Putting that into the calculator, now it will only take us less than 13 years to get there.

Okay. I get it.   Maybe you’re thinking you and your spouse saving 2 x $19,500 = $39,000 isn’t in the cards for you.

Of course, as we already said – less than 10% of people ever reach millionaire status. So then it stands to reason: If you want to accomplish something extraordinary, then you’ll need to be willing to do the things that most people can’t or refuse to do.

But don’t worry. Building a fortune fundamentally comes down to two basic strategies:

1. Saving early
2. saving more

Saving Early

When it comes to the concept of saving early, I think about this famous old saying:

“The best time to plant a tree was 20 years ago.  The second best time is right now.”

We can never go back in time and start saving.  But we can do something about it today. 

Blast through any excuses you have to get started. Trust me … it’s not as scary as you might think. Log on to your company’s 401(k) website and bump up your contribution rate. Go to any major financial service provider and open up an IRA. Just no matter what you do, don’t do nothing!

Every day that you delay saving is another day wasted where you could have been earning more. So don’t delay.  Start the process of saving more NOW!

Saving More

The opportunities for saving more money is actually more abundant than people realize. All of the time, we’re making decisions that can and will drastically impact how much we spend on each and every transaction.  Focus on reducing these transactions just a little bit at a time, and eventually they will build to bigger and bigger things!

For example, think about your day today.

• Did you eat out did you eat breakfast at home or buy something along the way to work?
• Is your car vehicle a luxury brand or something more modest? Does it get good gas mileage?
• When you filled up the gas tank, did you go to the gas station with the cheapest gas or just any gas station? Did the gas station have some sort of rewards card offering you a discount for each gallon purchased? How about the credit card used? Does it offer you any rebates cash rewards for each purchase you make?
• What are the clothes you wear to work? Are they name brand designer, or something you bought from a discount store like TJ Maxx? Are they less than one year old, or clothes that you had for a while and kept in relatively good condition?
• What are you going to do for lunch today? Did you bring leftovers from the night before that you eat at work? Or will you go to the nearest sit-down restaurant and spend $10-$15?
• When you get home tonight, what are your plans? Are you going to talk with your spouse and maybe take in some Netflix? Or you have plans to go to an expensive restaurant or game?

Want more ideas?  I can think of literally one thousand more ways you could save more money.

As you can probably tell, each and every one of these decisions can impact how much you spend. And if you spend just a little bit less on each one, the savings will start to add up really fast. Multiply that out times every day of your life, and you will begin to see how thousands if not millions of dollars are slipping out from underneath you.

What can you do?

Take notice of your lifestyle. Make an audit of all the things you spend on a monthly or even daily basis. Where does things seem to get excessive? Are there any cup ask that can be made or areas where perhaps you’re just too lax?

The goal is never to strangle yourself financially by living like you’re poor.  That would be like a person stops eating altogether just saw that he or she can lose weight. We know we all know how badly that ends!

Instead, just like how proper diet is essential to your health, you need to be conscious of what lifestyle decisions you’re making and how those will affect your financial future.

Earn More Money

Saving more money is just one side of the financial equation when it comes to becoming a millionaire.

Another way you could speed things up is to start early more money too!

Obvious you say?

Perhaps not as much as you may think.

Earning more money is not something for the lighthearted or on ambitious. It takes a lot of effort and drive, even if it’s just a couple thousand dollars extra per year.

Where should you start?

Leveraging Your Career

The most obvious and probably the simplest place to look is your current job. Is there some position or extra projects you could take him which will earn you more money? Perhaps there is another position or promotion you could seek?

Could going back to school and getting another degree help you transition into a higher paying position? If so, then you may want to consider weigh in the cost of both the tuition and the time it would take to achieve this goal.

In some cases, they may not make any sense at all to stay at your current job, and to simply seek a more stable a higher paying one in a completely new field. This is exactly what Robert and Robin Charlton did to get there, as explained in their incredible ebook How to Retire Early.

Rob worked his way up to a higher paying position while his wife Robin changed occupations completely. This took them from making an average household income to upwards of $140,000 annually!

Making Money on the Side

Of course, no one ever said making more money has to only come from your job. Lots of people earn money on the side from any number of different side hustles and assets that they own.

Take for example owning rental properties. Someone with one or two rental properties could likely easier late taken a couple hundred or even $1,000 net income per month.

Own any dividend stocks? Dividend stocks are also classic form of passive income because you simply sit back and collect checks each quarter doing nothing more than owning shares of stock in a company.

For a ton of other great passive income ideas, please check out our extensive list of ways to make money on the side here.

The important thing to keep in perspective is that in all of the situations, you should never let lifestyle inflation ever creep up upon you. In case you don’t know, lifestyle inflation is when you tend to spend more money simply because you earn more.

This is not something we want to do! Since our goal here is to save more, where anymore so that we can create a bigger delta between what we spend and what was safe.

Is a Million Really What You Want?

Even though becoming a millionaire would be an admirable accomplishment, its important to keep your TRUE financial needs in perspective.

What do I mean by this? Well, consider the question: Do you REALLY need a million dollars to retire and be happy?

Think about that question long and hard. Have you ever really sat down and truly worked out how much money you think you’ll need to become financially free? For some people, the answer might in fact be much less than one million dollars.  In fact, this was a question I wanted to explore so deeply, I wrote an entire ebook called “How Much Money Do I Really Need to Retire and Achieve Financial Independence?”

The answer is just as unique as you are. Some people might need $5 million dollars to retire while others might only need $500,000.

To give you a rough idea of how this all works, use this simple equation. Take the amount of money you think you will need each year for retirement and multiply it by 25. For example, if you said $40,000 per year would be enough to live on, then $40,000 x 25 = $1,000,000 would be fine.

If you said $100,000, then you’d need $2.5 million to be financially secure. But what if you have other sources of income and will only need $24,000 per year? Than you’d only require $600,000. (In my ebook, we get into some more advanced considerations that could have you doing even more with less money saved.)

Remember: The goal, of course, is not to simply become a millionaire. You want to become financially secure and happy for the rest of your life. Money is never actually the prize. Its what you do with your time as a result of having more of it that really counts.

Readers – What are your strategies for becoming a millionaire? What tricks or methods have you used to safely accelerate your savings rate and build up towards your financial goals? How many of you have reached millionaire status?

Photo credits: Pexels, Unsplash

The post How to Become a Millionaire – The Simple Way to Save $1,000,000 appeared first on My Money Design.

If you’ve got questions about how 401(k) matching works, there’s only one phrase you need to remember: Don’t leave free money on the table!

401(k) employer matching contributions are one of the biggest reasons why American workers should utilize their 401(k) plans.  Simply put, they are an opportunity to earn more money from your employer without any extra effort.

When some generous employers match their employees’ 401(k) plans dollar for dollar, this is effectively the same thing as getting a 100% return on your investment!  When was the last time you found an investment opportunity like that?  And what’s crazy is that all you have to do to take advantage o this opportunity is to merely participate in your company’s 401(k) plan.

Yet millions of working Americans are passing up this chance to get free money every year.  According to the Motley Fool, approximately 20% do NOT contribute enough to their 401(k) plans to get their full 401(k) match.

Think about it this way: If your boss was walking around the office passing out free $100 bills, you wouldn’t let this chance to get free money pass you by.  But when people don’t contribute enough to their 401(k) plans to earn their full employer match, they are basically missing out on the same opportunity.

For years, I’ve watched my 401(k) employer matching contributions add up on top of my personal contributions.  Not only does this increase my overall nest egg balance for the year, but it also creates more wealth volume for compounding returns to work their magic and grow exponentially.    

When done correctly, 401(k) matches can add up to tens or even hundreds of thousands of dollars over the years on top of your personal retirement contributions.

So to better understand how you can maximize this benefit and not leave money on the table, let’s dig in to how 401(k) employer matching works and add an extra six-figures to your nest egg!

What Is a 401(k) Contribution Match?

A 401(k) contribution match is when your employer deposits money into your 401(k) retirement plan alongside the contributions you’ve made.

Why do they do this?  Employers will often make matching contributions as a way to encourage their employees to be more active participants in their 401(k) retirement plans. 

How Does a 401(k) Employer Match Work?

The way a 401(k) employer match works is simple. 

For every dollar that is taken out of your paycheck to go into your 401(k) retirement account, your employer will also give your 401(k) the same or some percentage of your contribution. 

These employer contributions are then generally capped up to some pre-determined ceiling.

For example: Let’s say you earn $50,000 per year, and you’ve got an employer who matches dollar for dollar up to 5% of your salary.  If you periodically contribute 5% into your 401(k) for a total of $2,500 for the year, then your employer will also contribute $2,500 on top of that for a total of $5,000 at the end of the year.

The Tax Benefits of 401(k) Matching

Just like your contributions to a traditional 401(k) are taken out before your income is taxed, employer matches are also treated in the same way.  They are “tax deferred” meaning you do not pay any taxes on them at the time they enter your 401(k).

Both your personal contributions and your employer matching contributions will continue to grow in your traditional 401(k) plan as tax-deferred for years and years.  During this time, you won’t pay any taxes on the earnings you make off your investments.  When you finally decide to retire and start making withdrawals, this is when you will start paying taxes. 

What If I Have a Roth 401(k)?

Because 401(k) employer matching contributions are always tax-deferred, they must be handled just like a traditional 401(k) plan.  Therefore, if you’ve decided to contribute to a Roth 401(k), then your financial provider will effectively set you up with two 401(k) accounts.  Your personal contributions will go into the Roth account after being taxed, and your employer contributions will go into the traditional account before taxes are taken.

Are 401(k) Employer Matches Required By Law?

No, 401(k) employer matching is not required by law.  It is completely up to your employer to decide how much they would like to offer you (if anything at all).

401(k) Employer Matching Contribution Formulas

There are lots of different ways that employers can structure 401(k) matching contributions.  Here are some of the most common employer matching formulas:

• Dollar for Dollar.  For every $1 you contribute, your employer will also contribute $1.
• Partial.  For every $1 you contribute, your employer may only wish to contribute a partial amount such as 50 or 25 cents.
• Something for Nothing.  In rare instances, some employers may decide to contribute a percentage to your 401(k) regardless of what you contribute; even if it’s nothing at all.
• Combination.  By far, this is the most typical method of 401(k) employer matching you will hear about.  For example, at the company I work for, we’re offered a dollar for dollar match up to the first 3% of our pay and then another 50 cents for each dollar for the next 2% of our pay.  Effectively, this works out to a 4% match overall, but the structure encourages the employees to contribute at least 5% of their paycheck.

Matching Caps

Again, please note that in almost all instances of 401(k) matching, your employer will place some “cap” or upper limit as to how much they will give you.  This could be any number they choose.

Profit Sharing / Bonuses

If your employer has a profit-sharing program or gives out annual bonuses, they might also decide to make an additional contribution to your 401(k).  Again, the amount of this additional contribution is up to the discretion of the employer.  It may also vary from employee to employee.

How Much Money You Could Make With 401(k) Matching

Let’s say you’re in a situation  where you haven’t signed up for your employer’s 401(k) plan yet.  How much money are you leaving on the table by passing up your full 401(k) match?

Let’s create an example using some modest assumptions:

• You earn a gross salary of $60,000 per year.
• Your employer will match you 25 cents for every dollar you contribute up to 8% of your salary.

Using these figures, your 401(k) employer match would be $1,200 per year. 

Although that may not sound like a lot of money to some people, you have to remember that as time goes on, compounding returns will help to grow this money exponentially.

How much are we talking?

Assuming an average annualized return of 7% per year, you would potentially be missing out on:

• $49,195 after 20 years
• $113,353 after 30 years
• $239,562 after 40 years

Wow!  You could have an extra six-figures in your nest egg from just the employer contributions alone.  This calculation doesn’t even include your personal contributions.

Again: Definitely do NOT wait.  Sign up for your 401(k) plan right away and start getting your employer matches immediately!

What is a Good 401(k) Match?

“Dollar for dollar” or “something for nothing” may seem like the best 401(k) matching plans.  But if they have low cap limits, then this could be deceiving.

To really understand if you’re getting the best 401(k) match, calculate how much total money you stand to earn if you contribute the full amount up to your employer’s capped limit.  You can then compare this to the industry average and decide for yourself if your company is being generous.

For example, which plan sounds better to you?

1. A dollar for dollar match up to 4% of your salary.
2. A match of 50 cents to a dollar up to 9% of your salary.

 Doing the math:

1. 1 x 4% = 4%
2. 0.5 x 9% = 4.5%

Since plan 2 is greater than plan 1, plan 2 is the better deal and will ultimately result in more money. Just be sure to contribute the max amount needed to get the full amount every year.

What is the 401(k) Matching Average?

According to Fidelity, the average 401(k) employer match is approximately 4.7% of your gross pay.  For example, if you earn $60,000 per year, then the average 401(k) employer match for the year would be $2,820.

Because there are so many different combinations of ways employers structure their 401(k) matching contributions, it’s often helpful to express this number as a percentage of your overall salary.  That way, you can easily make comparisons from company to company.

How Do I Qualify for 401(k) Employer Matching?

Generally, all you have to do to take advantage of your company’s 401(k) employer matching program is to start contributing to your 401(k)!  It’s really that simple.

To know for sure, go to your company’s human resources (HR) department and ask them if they offer 401(k) matching contributions.  Ask about their rules for the program and get them in writing (preferably).  Be sure you’re clear on their rules and ask questions if you need further clarification.  Again, don’t let the embarrassment of asking a question hold you back from potentially earning thousands of extra dollars over time! 

Spread Out Your 401(k) Contributions for Maximum Benefit

Remember that in order for you to get your full 401(k) employer match, you need to be sure to always be contributing at or above your employer’s matching contribution limit for each and every paycheck.

For example, if you run into some trouble financially and need to turn off your 401(k) contributions, understand that you will also be forfeiting your employer matches.

There is also some caution that needs to be taken if you are at the other end of this extreme.  Let’s say you are an employee who maxes out their 401(k) contributions every year.  Beware that some personal finance blogs out there will recommend that you “front load” your 401(k) contributions for the year; meaning you contribute a substantially large amount to your 401(k) for the first few months until you reach the IRS limit.  An example of this would be:

• You earn $60,000 per year and are paid bi-weekly.  That means you earn $2,307.69 gross every two weeks.
• You set your contribution rate to a high rate of 50% and contribute $1,153.85 per paycheck. 
• After just 17 paychecks for the year, you’d already reach the IRS maximum contribution for the year.

The problem with this is that since you are paid 26 times for the year, for at least 9 more paychecks your contribution would be 0.  Therefore, you’d miss out on the 401(k) employer match for these remaining paychecks.

To be sure, again, make sure you ask your company’s HR department and fully understand how they structure their 401(k) matching payments.

How Vesting Affects Your 401(k) Match Ownership

While your contributions to your 401(k) always 100% belong to you, remember that there may be some “time” qualifications for the contributions from employer before this money belongs to you.  This is a process known as “vesting”.

A typical example of the vesting process may be that for every year the employee works for a company, they become 25% more vested in their 401(k).  This would mean:

• If the employee leaves the company after 0.5 years, they would be entitled to keep 0% of their 401(k) employer contributions.
• If the employee leaves the company after 1 year, they would be entitled to keep 25% of their 401(k) employer contributions.
• If the employee leaves the company after 2 years, they would be entitled to keep 50% of their 401(k) employer contributions.
• If the employee leaves the company after 3 years, they would be entitled to keep 75% of their 401(k) employer contributions.
• If the employee leaves the company after 4 years, they would be entitled to keep 100% of their 401(k) employer contributions.

Why do employers do this?  Vesting is generally used to motivate employees to stay loyal to the company and work with them for the long-term.

Again, this is just one example.  By contrast, my current employer offers a vesting schedule where you qualify for 100% of the contributions at the time of hire.  This means all your 401(k) matching contributions are yours starting from day 1! 

Just like the 401(k) matching contributions themselves, it is up to the discretion of the employer to decide how they would like to structure their vesting process.

To find out more about 401(k) vesting works, click here.

Employer 401(k) Contribution Limits

There are some limitations as to how much your employer can contribute to your 401(k). 

According to the IRS, employers are not allowed to contribute up to the lesser of $56,000 or the employees annual compensation to any employee’s 401(k)

Again, remember that this limit is the combination of both matching contributions and any profit sharing / bonus payments.  For most employees, the 401(k) matches they receive from their employers will never exceed this IRS limit.  But if your company offers profit sharing or annual bonuses, it is possible they could make additional contributions to some employees that would exceed this limit.

Highly Compensated Employees

To help protect against employers unfairly giving select employees substantially more 401(k) contributions than others, there is another test that employers must pass known as “highly compensated employees”.  According to this test, highly compensated employees cannot contribute more than 2% above the average contributions made by non-highly compensated employees.  Otherwise the company would be found to be discriminating in favor of their highest earners.

For more information about highly compensated employees, check out this article here.

Photo credits: Pexels, Unsplash

The post How 401(k) Matching Works – Don’t Leave Free Money on the Table! appeared first on My Money Design.

Question: Is it possible to retire on $500K (i.e. $500,000) in your 50’s and 60’s?

Unfortunately, not all of us are great savers.  Most financial articles will recommend that you’ll need at least $1 to $2 million dollars in savings before you can even consider retirement.

But the reality for a large segment of the population is anything from that.  To give you an idea, a study from the Government Accountability Office found that those savers between the ages of 55 to 64 have an average of just $104,000 in their retirement accounts.

This is not surprising at all. With the responsibility of saving for retirement having shifted from company-sponsored pensions to individuals, the shocking truth for many people will soon be “whatever you have saved is all there is”.

Even though the easy answer is to simply continuing working full-time, sometimes “life” has other plans for you.  Health issues, taking care of spouses, job elimination, and dozens of other challenges may force you to consider retirement earlier than you may have previously planned.

Therefore, the question remains: If you’re in your 50’s or 60’s and short on retirement savings, how do we make the most of it?  How can we stretch those dollars to give you the best and most reliable outcome possible?

In this post, we’re going to thoroughly explore your options and see how we can retire on a $500,000 nest egg.  (Note that you can still follow along and re-work the examples if you’ve got other levels of savings.  The logic behind the strategies will still apply.)

Disclaimer: Some of the links in this post to useful tools we recommend are affiliate partners. This is at no additional cost or risk to you. To learn more, check out our Privacy Policy.

1- Exercise Lifestyle Moderation

First things first, if you’re going to have any chance of success with retiring on just $500K, then we need to get real:

You’re going to need to really concentrate on making some lifestyle changes and exercise a strong sense of moderation when it comes to your spending.

Let me be blunt: Nothing in the strategies we’re going to suggest will produce anything close to the type of glamorous lifestyles you might see on TV or in magazines. Images like these portray lifestyles that a majority of the population will unfortunately never achieve.  So do yourself a favor – ignore them.

Instead: Focus on the things that really matter to you. Why? Because they’re going to help you stay the course when it comes to your money!

What Matters to You?

Chances are that if you are even thinking about retirement, then you value the one thing that should matter to us the most: Time.

Time is something that we’ve spent our entire working years trading for money. And at some point, we reach a cross-roads where we’d rather spend our time doing something else other than going to our jobs.

Maybe its spending more time with your spouse, your children, grandchildren, etc. Maybe its finally traveling or taking up a hobby that you’ve always wanted to pursue. Maybe you’re just finally ready to be done!

No matter what your reason is, let that be your motivation! Let it be the thing you prioritize above all else.

Why? Because when it comes to your money, focusing on the priorities that matter the most to you will be the things that will help you stay on track.

Work Your Budget

The Internet is a sea of success stories of people who have learned how to retire on less than $1 million.

If I could find one common element to nearly every story I’ve read, it’s this: The secret of retirement success (on any income) was in budgeting their money and becoming very careful with their spending. 

What’s the best way to do this?

A budget is nothing more than simply understanding how much money is going in and how much money is going out. And as long as you can make sure less money is going out than in, then you’re going to be okay!

Just like someone who is on a diet and counting their calories to make sure they don’t exceed the number they are allowed for the day, the same good habits can be applied to your finances finances to make every dollar count as well.

Again, I can’t stress this enough: Let the thing that motivates you help keep your spending under control.

To help you get there, here’s a few helpful links:

• 1,000 Ways to Save
• The 10 Best Practical Ways to Budget Your Money and Save More
• Monthly Budget Not Working? Why An Annual Budget Is Better
• What is the Minimum Retirement Savings You Could Comfortably Live On?

Okay! So now that we’ve made retiring successfully a priority and understand how a budget will make that happen, let’s get to the nuts and bolts of how much retirement income we can expect with a nest egg of $500K.

2- Start With The 4 Percent Rule

If there’s one fear that most people share when it comes to retirement planning, it’s this:

How much money can we withdrawal safely each month from our nest egg (our $500,000) without running out of money too early and having to return to work full time?

To answer this, a very useful starting point is to consider something called the “4 Percent Rule”. 

What is the 4 Percent Rule?

The 4 Percent Rule is a popular guideline widely accepted in the financial planning community. It comes from a study that was conducted from a financial adviser named Bill Bengen to determine what the optimal safe withdrawal rate should be.  After looking back at several decades of historical market returns, his conclusion was that a retiree could reliably withdraw 4 percent of their initial nest balance for at least 30 years with inflation adjustments.

What does that mean? To put this into context, if you have a nest egg of $500,000, this means you could safely withdraw a starting balance of 4% or $20,000 and then adjust for inflation every year after that … regardless of what your actual portfolio value is.

For example:

• Year 1 = $20,000 (or $1,667 per month)
• Year 2 = $20,600, an increase of 3%
• Year 3 = $21,218, another increase of 3%
• And so on …

Statistically according to the 4 Percent Rule, no matter how your investments perform, your nest egg would not run out for at least 30 years. In fact, according to financial guru Michael Kitces, after 30 years less than 10% of the time does the retiree EVER finish with less than the starting principal.

For a lot more information about how all of this works, you can read a very exhaustive article I wrote called “The 4 Percent Rule – Everything You’ve Ever Wanted to Know”.   

Test the 4 Percent Rule for Yourself

Skeptical that the 4 Percent Rule actually works? You can see this in action for yourself using any number of free online calculators. Personally I like Personal Capital’s Retirement Planner. It gives you a graph showing exactly how long you can expect your money last and your probability for success.

To make it as accurate as possible, all you have to do is create a free account and then link out to your external retirement funds.  From there the Retirement Planner will create a personalized portfolio projection based on 5,000 Monte Carlo simulations showing you the best and worst-case scenarios for your nest egg based on your input. It’s way better (and more fun) than trying to crunch numbers on a spreadsheet.  Definitely give it a try!

Avoiding the Age 59-1/2 Penalty

You might be saying: Wait! I thought you can’t make withdrawals from retirement accounts until at least age 59-1/2.

… And you’d be right (mostly). The IRS has a rule that if you try to take your money out of a traditional 401(k) or IRA account before age 59-1/2, they will impose a 10% penalty on the withdrawal.

However, you should know that you’re not necessarily “stuck”.  For people myself who are determined to retire long before age 59-1/2, I spent years collecting as many strategies and tricks for getting around this rule. Eventually I complied them all into a single ebook called “How to Unlock Your Savings Before Age 59-1/2 Without Penalty”, and I guarantee you’ll find plenty of useful tips in there.

Minimize Your Taxes

Please note that for the 4 Percent Rule, it is always assumed that your withdrawals are taken pre-tax.  This means you will still need to pay taxes on this money.

However, you can easily side-step this problem if you can find a way to save or convert your retirement savings into a Roth IRA.  Remember that with a Roth IRA, all of your contributions are available tax-free and penalty-free.  The capital gains portion is also available tax and penalty-free, but not until after age 59-1/2.

3- Don’t Forget About Social Security

Social Security is something that a lot of U.S. tax-payers forget about when it comes to retirement planning.  But if you plan to retire on $500K, you are going to want to make sure you get every penny you’re entitled to.

You can determine how much money you’re scheduled to receive by going to Social Security’s website and logging into your account.  According to their figures, the average payout is approximately $1,341 per month or $16,092 per year.  Of course this amount will vary depending on how long you’ve worked and how much you’ve earned over the years.

Generally speaking, you can start collecting your Social Security benefits starting at age 62.  Therefore, depending on how old you are now and how much money you’ll need, you may want to gauge your retirement date around this criteria.  It could mean yet another reliable income stream for you.

Combining the average reported Social Security monthly benefit with withdrawals from our nest egg savings example, this means you could be looking at:

$1,667 + $1,341 = $3,008 of total income per month (or $36,092 per year total).

Double-Down with a Spouse

Don’t forget: If you’ve got a spouse who has also worked and paid into the Social Security program, then you’re both eligible to receive benefits.  So be sure to check into each individual’s account.

Got a While Until Social Security?

Is your plan to retire in your early 50’s, and therefore it will be a while until you are in your 60’s and can start receiving Social Security?  If so, no problem.  We did a study to see how much higher of a safe withdrawal rate you could start with at a younger age if you expected to start receiving Social Security later on.  On average, the future benefit added approximately 0.5% in the near term.  Click here to read the full study.

4- How to Increase Your Safe Withdrawal Rate

Let’s go back to the 4 Percent Rule and see how we can optimize it further.

How long do you need the money?

First of all, remember that we said the “4 Percent” figure is tied to a period of 30 years.  According to another famous paper on safe withdrawal rates known as the Trinity Study, if you only need your nest egg to last for a shorter time period (perhaps thanks to an upcoming annuity, pension, or some other delayed income stream), then you should be able to use a higher rate.  For example, a portfolio with a 5% withdrawal rate for 20 years would have almost the same probability for success as one with a 4% withdrawal rate for 30 years (94% vs 96%).

(Alternatively, if you’re much younger and want your money to last for 50 years or more, than you might have to go with a lower rate such as 3.5%.)

Playing the Probabilities

In the original paper about the 4 Percent Rule, the author had determined that in the worst of economic conditions this safe withdrawal rate would last for a minimum period of 33 years.

However, there were many periods throughout history where higher safe withdrawal rates ended up working out just fine.  The problem is that no one knows when those safer periods are going to happen.  Therefore, this becomes a question of probability: What kind of odds do you need to feel safe?  100%?  90%?  85%?

Technically, you can increase your withdrawal rate to any number you want.  But of course the higher up you go, the more your odds of success decrease, and the greater your chances of running out of money increase.  Again, we can refer to the Trinity Study to see what kind of probabilities they predict. 

Using the Shiller CAPE to Safely Gauge a Higher Withdrawal Rate

So how can you predict when a higher safe withdrawal rate might be okay to use?

An economic value known as the Shiller CAPE can be used to gauge whether the market is over or under-valued.  It’s been shown that this factor correlates to market returns over the next 15 years, and this can help us determine whether or not higher withdrawal rates may be safe.

In a famous paper from financial researcher Michael Kitces, it was found that the safe withdrawal rate could be adjusted as high as 5.5% when the Shiller CAPE was equal to 12 or below.

Combining This All Together

Taking everything we’ve said in this section into account, if we can squeak out another 1.0% on top of our previous safe withdrawal rate, then this will yield another $5,000 of additional income per year.

This brings our annual total income up to $41,092, or $3,424 per month.

5- Reducing Inflation Adjustment to Get More Up-Front

One aspect of the 4 Percent Rule as well as many other safe withdrawal rate studies is that they all mostly assume that you will compensate for inflation each year.   In other words, you’ll add about 3% to the prior year so that your money maintains the same amount of purchasing power.

However, if you were to delay or even reduce the amount your inflation adjustment, this could allow you to start the whole process using a higher rate.

How much higher are we talking? 

If we again refer to famous Trinity Study, it was shown that when the retiree makes absolutely no inflation adjustments at all, they could actually start off their retirement withdrawing as much as 7 percent!  Now while that may not be practical (and I certainly wouldn’t recommend it), the idea does give you some indication of how this strategy could work to your benefit.  Adjustments to your inflation rate could alter your withdrawal rate somewhere between 4 and 7 percent.

To more accurately quantify the situation, I did my own analysis and was able to demonstrate how something as simple as reducing your inflation rate by 1.5% per year would allow you to start your retirement with a safe withdrawal rate that is 0.5% higher than what you would have normally started with.

Lots of Us Already Don’t Adjust for Inflation

While you will certainly have to make some adjustments to your income over time to account for inflation, this may not necessarily have to happen every year or to the same degree as most financial planners would recommend.  Think about how many times you or people you know may not get a raise this year (or several years in a row).  But we don’t go bankrupt.  We find ways to adjust and make due.

Assuming this strategy allows us to yield yet another 0.5% on top of our previous example, then this will yield another $2,500 of additional income per year.

This brings our annual total income up to $43,592, or $3,633 per month.

Bonus: Alternative Strategy – Dividend Income

If our suggestion in Tips 4 and 5 of playing the odds with different withdrawal rates seems too risky, or if you’d like to seek a potentially higher rate of return, then I will introduce you to an alternative strategy: Generating income using dividend paying stocks.

Dividends are the payments you receive as the owner of stocks from certain companies; usually from their profits.  Thousands of companies offer them.  Generally, as a shareholder, you will be paid on a quarterly basis.  These payments can be any domination and are always subject to change.

One very popular retirement income strategy is to build up an entire portfolio of dividend paying stocks and then live off of the payments they generate.  You literally don’t have to do anything except be a shareholder of the stocks.

Where to Look

Even though the stock market as a whole tends to pay an average of around 2 percent, it is possible to build a portfolio that pays around 4 percent per year.  Two places you could start looking would be The Dogs of the Dow and The Dividend Aristocrats.

Often times too you’ll see magazine articles or blog posts claiming to teach you how to pick dividend paying stocks that pay an average of 5 percent or more.  However, be careful!  The higher the dividends you’re after, the more complicated it will be to deliver consistent results.  If you’ve never purchased or traded individual stocks in the past, you might want to consult a professional first.

Pros & Cons

As with any strategy, there will be pros and cons to it.

One of the best parts about it is that you never have to touch the principal investment (in theory).  You will only live off of the dividends.  So no matter what happens to the stock market or what price they fluctuate to, it will not matter as long as the dividend payments continue to roll in.

However, in practicality, you won’t necessarily want to cut yourself off from the principal completely.  If an emergency were to occur (… and one always does …) and you needed to sell your stocks, the last place you’d want them to be is down in price.

Furthermore, it is never recommended that a retiree holds their entire nest egg in 100% equities.  The fluctuations you might experience in portfolio value might be way outside your personal tolerance for risk.

For the dividends themselves, there is also no guarantee that the stock will continue to pay at the same level or higher for forever.  Though some companies have a much better track record than others, this is still no promise.

Also, beware of chasing after dividend yields that seem too good to be true.  For example, there are stocks out there that pay 10% dividend yields. But that doesn’t mean the stock is necessarily any good or that they company will continue to pay at this level forever.  Make sure that you only invest in strong, reputable companies that will continue to produce results.

6- Leverage Part-Time Income

Retirement doesn’t necessarily have to mean “no work at all”.  There are lots of retirees who gladly welcome the opportunity to work 1 or 2 days per week earning a little part-time income.

For example, if you have any talent at writing, you could easily earn $1,000 per month by picking up a few assignments at $50 to $100 each from any number of online job boards.  The great thing about this particular example would be the flexibility that it would provide.  You could choose when and where to work, and complete them at your leisure.

Of course there are hundreds of examples we could through: Consulting, sales, teaching, coaching, photography, graphic arts, crafting, … and many, many more.

A Little Work Might Be Good For You

Though the idea of going back to work, even for just a little bit, might not sound appealing, there is a psychological factor that you may be underestimating.  One of the biggest complaints retirees have is that quite frankly: They get bored.

They suddenly have all of this new found time on their hands and they have no idea how to fill it.  In attempt to find some semblance of purpose or even just to be social, they gladly welcome the opportunity to take on a new part-time job – perhaps doing something that they’ve always had as an interest or hobby.

Suppose we assume you are able to find a part-time gig generating an extra $1,000 per month.  This brings our example up to $55,592 per year or $4,633 per month.

7- Tapping Your Home Equity

Last but not least, if you own a house, then you might be able to tap into its equity using one of two ways to provide an additional source of income.

Downsize / Relocate

The first would be sell your house out-right.  By selling your house and moving to a smaller one and/or relocating to a lower cost of living area, you could unlock your home’s value and add it to your nest egg.

The good news too is that for many middle class Americans the profit from the sale of a home (up to $500,000 for married couples) is tax-free.

This has been a strategy used by many retirees, including one of my favorite early retirement success stories, “The Charltons”.  In their awesome ebook “How to Retire Early”, they talk about how they were able to generate $300,000 in equity from the sale of the home which in turn helped them to retire in their 40’s.

Reverse Mortgages

If you like your home but would rather not move, another option on the table would be to use a reverse mortgage.

Okay … so I know reverse mortgages often get a bad rap.  But to be fair: Just like any financial product out there, I’m sure there are lots of legitimate options available.

The way a reverse mortgage works is that the lender gives the home-owner a pre-determined amount of money (usually some percentage of the value of the home).  When the owner moves, dies, or the lending term ends, the owner then has to pay the lender back.

According to a very detailed calculator provided by retirement researcher Wade Pfau, a $200,000 house may be able to yield as much as $776 per month ($9,312 per year) in extra revenue.

This brings our cumulative example up to $64,904 per year or $5,409 per month.

Keep in mind that if you are considering this option, you must first be 62 years or older to apply.  Also your home should be paid off or nearly paid off.

Conclusions

Though a retirement based on $500K may not be very luxurious, given the current state of retirement savings in the U.S., it may become a forced reality for those who have little options.  Therefore, we need to have strategies for stretching our dollars as far and safely as possible.  By exercising lifestyle moderation, sticking to a budget, and staying within the confines of the tips we’ve explored here, then you’ll be putting yourself in the best possible position for success.

If you’re still a little ways away from retirement and have more time to save, then I encourage you to check out my ebook “Save Better!“.  In this book, I’ll teach you exactly what tools to use to make the most of your savings, avoid taxes, and maximize your returns.

Readers – What do you think?  For those people in their 50’s and 60’s who may be forced into retirement, what advice can we offer them?  How can someone retire on $500K while striking a balance between safety and comfort?

Images courtesy of Pexels, Pixabay, Flickr, and FreeDigitalPhotos.net.

The post How to Retire on $500,000 In Your 50’s or 60’s appeared first on My Money Design.