People approaching retirement age with little savings may have a bumpy road ahead. But there are certain things that can be done in order to build their nest eggs as rapidly as possible, and to ensure at least some money will support them in retirement.
TUTORIAL: Retirement Planning Basics
1. Fund Your 401(k) to the Hilt
An employee in this age category who is offered a 401(k) at work should consider funding it to the maximum amount. To provide you with a flavor for how powerful maxing out a 401(k) can be, consider the following:
An individual who is 40 years old and who contributes $17,500 annually to a 401(k) could accumulate more than $1.3 million in savings by age 65. This assumes an 8% return and no employer contributions (see Figure 1). That's a powerful savings tool, and it's evidence that workers nearing retirement should seriously consider funding their 401(k)s as soon and as much as possible. If this individual increases savings by the catch-up amount of $5,500, at age 50, this would lead to an additional $271,000 in savings.
2. Contribute to a Roth IRA
Roth IRAs offer investors a great way to save and grow money on a tax-deferred basis. There are some income limitations. For example, if you are single and your modified adjusted gross income (MAGI) is above $112,000 a year, your contribution limit is reduced; if you are single and your MAGI tops $127,000 your contribution limit is nil. For married folks filing jointly, there are contribution limitations for those with MAGI above $178,000. And above $188,000, the contribution limit is nil.
How much can one potentially sock away with a Roth? Consider the following example:
A 40-year-old who invests $5,500 each year and obtains an annual rate of return of 8% has the potential to accumulate more than $434,000 by age 65. Even a person who waits until age 50 and starts saving $6,500 per year (using the same return assumptions) can save as much as $190,000 by age 65.
A fully funded Roth IRA and 401(k) can help to rapidly build retirement assets.
3. Consider Home Equity
While a home should not usually be considered a primary source of retirement income, it can provide liquidity during retirement. To that end, older individuals might consider borrowing against the equity in their homes in order to fund living expenses. However, a reverse mortgage may make more sense because lending institutions may shorten repayment periods and increase repayment amounts for older borrowers. Selling a primary residence outright and moving to a smaller and less costly home may also make sense for older individuals; in many cases they rarely need a big house, as children are usually off on their own.
However, selling a home should not be taken lightly. After all, in many instances, it takes the homeowner 30 years to accumulate full equity ownership in the house. Therefore, it would be a shame not to obtain the largest amount possible from a sale. (For tips on selling your home, see Need Retirement Income? Sell Your House! and Downsize Your Home To Downsize Expenses.)
That said, individuals should consider current market conditions and whether it is the most advantageous time to sell. Naturally, homeowners should also consider any tax consequences. Married homeowners who file a joint tax return can generate profits of up to $500,000 without owing federal tax on the capital gains. For single individuals, the limit is $250,000. This is assuming that you meet certain requirements, such as that the home being sold is your primary residence and that you have not benefited from the capital gains exclusion on another home during the past two years. Additional requirements are explained in IRS Publication 523, available from the IRS.
Finally, sellers must consider the cost of living in the area they will be moving to. In other words, it's wise to make sure that the cost of buying a home and the cost of everyday items like groceries are generally less.
4. Take Full Advantage of Allowable Deductions
It's important to note that standard deductions aren't for everyone. In fact, if you have a large amount of mortgage interest, deductible taxes, business-related expenses that weren't reimbursed by your company, and/or charitable donations, it probably makes sense to itemize your deductions. (For more insight, read Which is better for tax deductions, itemization or a standard deduction?)
Sit down with a CPA and go over your personal situation to determine whether it makes sense to itemize. Then get in the habit of saving receipts and keeping good records. Remember, in the end it's not always what you make, but what you save that counts - particularly as you get closer to retirement.
5. Tap Into Cash Value Policies
While tapping an insurance policy for its cash should be considered a last resort, if the original need for the insurance is no longer there, it may make sense to cash out. However, before ever canceling any policy or accessing its cash value, you should first consult a tax advisor and an insurance professional to review your individual needs.
6. Get Disability Coverage
Don't forget to either obtain disability coverage or make certain that your job offers some sort of group disability benefit. The idea behind obtaining such coverage is simple: to protect yourself and at least a portion of your income and nest egg just in case the worst should happen.
Your chances of becoming disabled depend on your career and your lifestyle, but according to a 2006 press release from the U.S. Census Bureau more than 50 million Americans report some level of disability. Given that the U.S. population is right around 300 million, that's a substantial number. And it means that in order to protect your income and improve the chances that you will retire with some form of nest egg, it makes sense to at least consider some form of disability coverage.
The Bottom Line
Individuals in their 40s and 50s who have done little or no retirement planning are certainly at a bit of a disadvantage. However, with the proper planning and a willingness to save and invest, the odds are not insurmountable.
If you are in this age group and feel you are not where you want to be in the retirement planning game, you may find Retirement Savings Tips For 45- To 54-Year-Olds and Retirement Savings Tips For 55- To 64-Year-Olds helpful.
RetirementUnderstand why more and more Americans are deciding to retire in developing countries. Learn about the top five reasons why Americans retire to Costa Rica.
RetirementUnderstand why the Florida communities of Miami Beach, Palm Beach and Key West serve as magnets for the ultra-rich retirees who descend on the state.
ProfessionalsSoon to be retirees are often told it's best to wait until age 70 to collect Social Security. Here's why this is not always the best advice.
ProfessionalsBetween delaying filing, claiming strategies and taking advantage of special marital benefits, there are several ways to maximize Social Security.
RetirementSure, you can tap your permanent life insurance policy to help fund your retirement. But in most cases, an IRA is the better choice. Here's why.
Investing BasicsLearn about how the data suggests that the buy-and-hold investment strategy still works, even after the huge declines of the Great Recession.
RetirementDiscover five of the most desirable retirement communities for seniors located in the Austin/Georgetown metropolitan area in Texas.
Options & FuturesProfessionals choose the options available to you in your plan, making your decisions easier.
Investing BasicsChoosing a financial advisor isn't an easy task. Here's a list of the most important things to consider when planning for your financial future.
SavingsMillionaires have more in common than just their bank accounts. They share certain qualities that help them make it to the top.
There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>
Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
If you decide your current annuity is not for you, there is nothing stopping you from transferring your investment to a new ... Read Full Answer >>
A longevity annuity may be right for an individual if, based on his current health and a family history of longevity, he ... Read Full Answer >>
Your Roth IRA account grows over time thanks to two funding sources: contributions and earnings. While your contributions ... Read Full Answer >>
As long as your retirement funds are held in your 401(k) and you do not take them as distributions, your 401(k) cannot be ... Read Full Answer >>