People approaching retirement age with little in savings may have a bumpy road ahead. But certain steps can build a nest egg as rapidly as possible to ensure at least some money will be there for support in retirement.
- To catch up on retirement savings, consider starting my maximizing your 401(k) contributions and getting your full employer match.
- You'll also be able to make catch-up contributions (in addition to your normal contributions) to your IRA when you're age 50.
- You can leverage your home equity for a HELOC.
- Be mindful of how you can take deductions on your tax return to reduce your taxable income.
- Insurance policies with cash value may act as emergency funds, and disability coverage may also act as a safeguard against unforeseen costs.
1. Fully Fund Your 401(k)
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 sense of 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 the figure below. Note the annual contribution limit for 401(k)s is $20,500 per year for 2022 and $22,500 for 2023.
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.
Note that the total allowed catch-up contribution for those 50 and older is $6,500 per year for 2022, for a total of $27,000. The catch-up contribution increases to $7,500 for 2023, for a total of $30,000.
"Factoring in no growth at all, if you can sock away $24,000 a year from age 50 to age 60 (11 years), that’s $264,000 more saved for even the earliest unpenalized retiree. An extra $250,000-plus saved prior to retiring can make or break an income-producing portfolio lasting throughout retirement," says Martin A. Federici, Jr., AAMS®, MF Advisers, Inc., Dallas, Pennsylvania.
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 2022, if you are single and your modified adjusted gross income (MAGI) is $129,000 ($136,000 for 2023) or more a year, your contribution limit is reduced. If you are single and your MAGI is $144,000 or more for 2022 ($153,000 for 2023) you cannot contribute to a Roth IRA. For married folks filing jointly, there are contribution limitations for those with MAGI of $204,000 for 2022 ($218,000 for 2023). And at or above $214,000 for 2022 ($228,000 for 2023), 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 $6,000 each year and obtains an annual rate of return of 8% has the potential to accumulate more than $473,726 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.
Note that the yearly contribution limits for IRA—for both traditional and Roth versions—is $6,000 for 2022, and $6,500 for 2023. The catch-up contribution for those 50 years old and older is $1,000.
According to Michelle Buonincontri, CFP®, CDFA™, Being Mindful in Divorce, Scottsdale, Arizona:
Maximizing your Roth IRA contributions and utilizing Roth conversions when appropriate can really make sense. A Roth account allows for tax-free compounding, and when withdrawal rules are followed, the withdrawals, including the earnings, will be tax-free. This really creates an opportunity for tax planning later to minimize taxable income when you are in the withdrawal phase, and that can add up and help make your money last longer in retirement.
A fully funded Roth IRA and 401(k) can help to rapidly build retirement assets.
If your spouse doesn't work, you may still be able to make IRA contributions on their behalf based on special spousal IRA rules.
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. "A large portion of the population has most of their wealth tied up in real estate properties. This can be used in many ways to fund retirement. You can use a home equity line (HELOC) to draw from when needed, or you could sell, downsize, and live off the equity.
Whatever you choose, it is important to consider the impact on your monthly income. People are living longer than decades ago, so it is important to make sure you can have a sustainable income for many years to come," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Massachusetts.
A reverse mortgage may make 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 no longer 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.
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 capital gains. For single individuals, the limit is $250,000.
This is assuming that you meet certain requirements: The home being sold must be your primary residence, and you must not have 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, if you're not just moving to a smaller place in your own neighborhood, factor in the cost of living in the area you might be relocating to before making the decision. In other words, it's wise to make sure that real estate prices and the cost of everyday items like groceries are generally lower than where you live now.
4. Take Your 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.
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.
The IRS standard deduction is higher for individuals 65 years or older. In addition, you're allowed a higher standard deduction if you're blind.
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 data released by the CDC, 61 million Americans lived with a disability in 2022. In 2022, an estimated 26% of Americans had some sort of disability ranging from mobility, cognitive, hearing, vision, or other health ailment.
"Disability insurance is important to protect your savings," says Elyse Foster, CFP®, Harbor Financial Group, Inc., Boulder, Colorado. "Contact your employer or professional association for the most cost-effective options."
What Is the IRA Catch-Up Contribution Limit for 2023?
Individuals may contribute an extra $1,000 to the IRA if they are age 50 or older. This translates to a maximum IRA contribution limit for 2023 of $7,500.
Is It Too Late to Start Saving for Retirement?
No. The IRS has many facets in place that give advantages to older individuals saving for their future. This includes higher contribution limits compared to younger individuals.
How Much Do I Need Saved for Retirement?
One general rule of thumb is to aim for a monthly income roughly 60% to 80% of your pre-retirement annual salary. Though you may be spending less in some aspects of life, you may be spending more in others such as healthcare or travel. In addition, different advisors may lean higher or lower on this spectrum, and every individual's retirement situation will be different.
Is Social Security Based on the Last 5 Years of Work?
No, base Social Security is based on your lifetime earnings. You should consider your actual earnings over time and account for changes in your wages during your entire career. The average indexed monthly earning is generally based on the 35 years in which you worked the most.
The Bottom Line
Individuals in their 40s and 50s who have done little or no retirement planning are certainly at something of a disadvantage. However, with the proper planning and a willingness to save and invest, the odds are not insurmountable.