"You have to buy real estate!" Now, how many times do you hear that during a real-estate bubble? If you take this advice, it may be wise to ask yourself if you have too much money tied up in your home and not enough in savings. With all the talk of a diminishing social security system, the need to save more for retirement seems inevitable. So, let's look at some of the options for building that million you need to retire in style.

TUTORIAL: Budgeting Basics

Where Are Our Savings?
If you have a great deal invested in your house, remember, listed homes and other property can take anywhere from two weeks to more than a year to sell. Ask any agent who sold homes back in the 1980s, when prime interest rates were averaging over 11%! Still, property seems to be priority. In 2004, the household savings rate averaged a meager 0.8% of disposable income (the rate was 7% over the three previous decades). This 0.8% is the lowest level since the Great Depression (Business Week Online, "Our Hidden Savings,"January 2005). Is this because Americans are putting too much of their savings into their homes or are we just bad at saving money?

So, exactly how much should you save annually for your retirement? Although there is no correct answer here, most financial planners will tell you that you should be saving around 15 to 20% of your annual gross income. This figure may sound unattainable for many, but suppose your employer matches contributions of up to 6% of your salary - now you need to save only 9%!

Sizing up the Options
Let's look at how some retirement savings vehicles can help you reach your goals:

401(k), 403(b) and Other Employer-Sponsored Retirement Plans
These are perhaps the best savings vehicle for most of the working population. You need to take advantage of your company plan if one is available. Not only do the earnings in the account grow tax-deferred, but a simple contribution of 6% can help reduce your tax bill if the contributions are made on a pre-tax basis, as pre-tax contributions are excluded from your gross income for income tax purposes.

Traditional and Roth IRAs
Individual retirement accounts are available to those individuals with qualified compensation. Traditional and Roth IRAs are funded with after-tax dollars. However, if your income level qualifies, you can receive a tax deduction for contributions to your traditional IRA. The major difference between the two IRAs is that earnings in the Traditional IRA grow tax-deferred, while those in the Roth IRA grow tax-free. (For a more detailed comparison, see Roth Or Traditional IRA ... Which Is The Better Choice?)

Simplified Employee Pension (SEP) and SIMPLE IRAs
The SIMPLE IRA is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of themselves and their employees.

SEP IRAs are plans that can be established by the self-employed or those who have a few employees in a small business. The SEP lets you make contributions to an IRA on behalf of yourself and your employees. The SEP and SIMPLE IRAs are popular because they are simple to set up, require little paperwork and allow investment earnings to grow tax-deferred.

Taxable Brokerage Accounts
These allow you to invest additional funds after you have maximized all of your retirement account options. Brokerage (cash) accounts can also serve as good savings vehicles for a particular goal, such as a home or yacht. Be aware, you'll need to pay taxes on the income generated in these accounts in the year that it is paid. (For further reading on how finding a broker, see Brokers and Online Trading.)

Getting Disciplined
So you know about some of the powerful savings tools, but you may be wondering where you get the extra cash to invest. Well, there can be a number of places - it first starts with your budget. Match up your monthly income with your expenses for the month. Can you cut back on your dining out? Do you really need that manicure once a week? Can you save money on your current insurance? Try shopping around for other carriers for better rates. Do you really need permanent life insurance (whole or universal life) when you could be saving hundreds with term insurance? (see Buying Life Insurance: Term versus Permanent)

After you've skimmed down the budget, there are three keys to making your million dollars. First, as we already mentioned, you must take advantage of any type of employer match program. If you have a 401(k) plan at work and the employer matches up to 6% of your pay, you should contribute at least 6% of your pretax income to the plan. Second, set your accounts up on automatic investment plan, so each monthly income goes to forced savings. And lastly, invest in the best savings plans first and weed out the bad.

Reaching $1,000,000 with Ease
To take full advantage of your retirement savings vehicles, try to contribute the maximum limit. In 2011, you can contribute up to $16,500 to a 401(k) plan ($22,000 if you are age 50 or older by the end of the year); you can also contribute $5,000 to a Traditional or Roth IRA of your choice ($6,000 if you are age 50 or older by the end of the year). Keep in mind that the eligibility to contribute to a Roth IRA has some income limitations.

Let's take a look at how an average person, let's call him Joe, can reach this million-dollar goal by the time he retires at age 67 (34 years from now). Joe (single, age 33) has an annual gross income of $50,000, and his employer has a 401(k) plan and matches contributions up to 5% of Joe's salary. Joe is also committed to saving $4,000 a year in a Roth IRA. We'll assume his investments have a 7% return.{C}

Joe takes full advantage of the employer match and defers 5%, or $2,500, of his salary each year. His employer will then contribute $2,500 each year as per the matching agreement. (Assume Joe's salary remains the same until retirement) Here's the breakdown of his savings over the 34 years.

401(k) Roth IRA
Annual contributions of $5,000 Annual contributions of $4,000
Compounded at 7% for 34 years Compounded at 7% for 34 years
Equals $641,932.83 Equals $513,035.06
Grand Total of $1,154,967.89. Welcome to the Millionaire Club!
If Joe had started his plan at different ages, here\'s what his results would look like:
Starting Age Annual Investment Annual Return Value at age 67
25 $9,000 7% $2,075,690.16
30 $9,000 7% $1,443,036.62
35 $9,000 7% $991,963.39
40 $9,000 7% $670,354.41
45 $9,000 7% $441,051.65
50 $9,000 7% $277,561.96
55 $9,000 10% $160,996.06

The Bottom Line
At younger ages, you still have the time to be a little more risky with your investment selections, and seek out investments that have the potential to get you that 7% return or more. If you're looking at certificates of deposit and money-market investments, think again - you need to consider other investments such as equities to achieve returns that can outpace inflation. (To learn more, see Guide to Stock Picking Strategies.)

The chart above also demonstrates the value of compounding interest, one of the most valuable tools to accumulate significant wealth - the key is to start while you're young and stay disciplined. (see Delay in Saving Raises Payments Later On.) Stick to your plan! The ride may be slow and boring at times, but you'll be pleased with the long-term results.

Related Articles
  1. Retirement

    How Much Social Security Will You Get?

    You've been paying in for years - now it's time to find out what the system owes you.
  2. Taxes

    11 Things You May Not Know About Your IRA

    These little-known features will help you get the most out of your retirement savings.
  3. Taxes

    An Introduction To Roth IRAs

    Be sure to consider the tax benefits and the eligibility requirements of the Roth IRA.
  4. Retirement

    Introduction To SIMPLE 401(k) Plans

    Learn about the features and benefits of the plan that is a cross between a SIMPLE IRA and a traditional 401(k) plan.
  5. Options & Futures

    When Your Employer Cuts Your 401(k) Match

    In hard times, companies may stop matching your 401(k) contribution, but there are ways to offset the hit.
  6. Retirement

    Voluntary 401(k) Contributions: A Thing Of The Past?

    Contributing to your retirement plan may no longer be voluntary, but automatic enrollment has a number of benefits.
  7. Retirement

    401(k) Predators: Don't Become Prey

    Be leery of "free" financial education sessions - the providers may not be working in your best interest.
  8. Economics

    What Caused The Great Depression?

    Learn how government actions may have contributed to this major economic downturn.
  9. Term

    What are Pension Funds?

    A pension fund is a company-sponsored fund that provides income for employees in retirement.
  10. Investing Basics

    Understanding How Dividends Are Taxed

    Learn how dividends are taxed by the IRS, and understand the different types of dividend income as well as the capital gains tax rates.
RELATED TERMS
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. See-Through Trust

    A trust that is treated as the beneficiary of an individual retirement ...
  3. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  4. Linked Transfer Account

    Accounts held by an individual at a financial institution that ...
  5. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  6. Self Invested Personal Pension ...

    A tax-efficient retirement savings account available in Great ...
RELATED FAQS
  1. Can my IRA be garnished for child support?

    Though some states protect IRA savings from garnishment of any kind, most states lift this exemption in cases where the account ... Read Full Answer >>
  2. Why is my 401(k) not FDIC-Insured?

    401(k) plans are not FDIC-insured because they are typically composed of investments rather than deposits. The Federal Deposit ... Read Full Answer >>
  3. Can I use my IRA savings to start my own savings?

    While there is no legal reason why you cannot withdraw funds from your IRA to start a traditional savings account, it is ... Read Full Answer >>
  4. Can creditors garnish my IRA?

    Depending on the state where you live, your IRA may be garnished by a number of creditors. Unlike 401(k) plans or other qualified ... Read Full Answer >>
  5. How does an IRA grow over time?

    Individual retirement account, or IRA, growth depends on many factors, including what types of investments are included in ... Read Full Answer >>
  6. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!