Becoming a millionaire may sound impossible to some people, but it doesn't have to be an out-of-reach pipe dream. With careful planning, patience, smart savings and investment plans, and keeping a tight reign on spending above your means, it is possible to make a million dollars. Whether you reach the one million mark or not, the need to save more for retirement is crucial. So, let's look at some of the options for building that million you need to retire in style. As you'll note, the best way to do this is to start as early in your career as possible. As you get older, you will need to save more to reach that million-dollar goal.
Home Equity as an Asset
According to December 2018 data provided by CoreLogic® (NYSE: CLGX), from its Home Equity Report for the third quarter of 2018, “U.S. homeowners with mortgages (which account for roughly 63 percent of all properties) have seen their equity increase by 9.4 percent year over year, representing a gain of nearly $775.2 billion since the third quarter of 2017.” In addition, the average homeowner gained over $12,000 in equity, according to the CoreLogic's report.
This may be good news for homeowners, but if you need access to money fast, or you are trying to put away millions for your retirement, home ownership may not be the best route. For example, listed homes and other property can take anywhere from two weeks to more than a year to sell, and high prime interest rates typically make selling more difficult. Ask any agent who sold homes back in the 1980s, when prime interest rates were averaging over 11%. In February 2019, the most recent figure available, the prime interest rate was 5.50%.
In 2005, the household savings rate averaged a meager 2.69% (the rate had been roughly declining from 13% since the 1970s). In 2016, according to the Organisation for Economic Co-operation and Development—it was 5.04%, down from 6.29% the year before. In December 2018, the most recent figure available, the household savings was 7.60%.
Perhaps the 2008 Great Recession increased the savings rate slightly from before, but it's still not much. Is this because Americans are putting too much of their savings into their homes or are we just bad at saving money?
Whatever the answer, the point is that you can't rely on your home to provide for your future; you need other assets and those will likely come from savings (unless you win the lottery).
Exactly how much should you save annually for your retirement? Although there is no correct answer here, most financial planners will tell you that, depending on your age, 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 vehicles 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. As per the IRS, the elective deferral limit for 2019 is $19,000 or $25,000 if you are age 50 or older.
Traditional and Roth IRAs
Individual retirement accounts are available to those individuals with qualified compensation. Traditional and Roth IRAs are both 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?) In 2019, you may annually contribute up to $6,000, or $7,000 if you are age 50 or older.
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 boat. Be aware, you'll need to pay taxes on the income generated in these accounts in the year that you receive it. (For further reading on how finding a broker, see Brokers and Online Trading.)
Now that you know about some of the powerful savings tools, where do you get the extra cash to invest? The first place to start is your budget. Match 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 extracted expenses from 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) or a 403(b) 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 up your accounts on an automatic investment plan, so that a portion of each monthly income goes to savings. Lastly, choose your savings plans to maximize the power of your investments.
To take full advantage of your retirement savings vehicles, try to contribute the maximum limit. Remember In 2019, you can contribute up to $19,000 to a 401(k) plan ($25,000 if you are age 50 or older by the end of the year); you can also contribute $6,000 to a Traditional or Roth IRA of your choice ($7,000 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, (average rates of return range from 5 to 10%, as of 2019).
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. For the purposes of this chart, we'll assume Joe's salary remains the same until retirement (In real life, one hopes he'd get raises and his nest egg would grow even more). Here's the breakdown of his savings over the 34 years.
|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|
The Bottom Line
Of course, how much you actually earn depends on how well your investments do. At younger ages (Joe, in the example above, is 33), you have the time to be a little more risky with your investment selections and seek out choices that have the potential to get you that 7% return or even more, as the average is 10%, as of February 2019.
That means not putting much of your money in certificates of deposit and money-market investments; you need to consider choices such as equities to achieve returns that can outpace inflation. (To learn more, see Guide to Stock Picking Strategies.) In 2019, inflation will be 2.2% up from 1.9% in late December.
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, and make and keep a long-term financial plan. The ride may be slow but you'll be pleased with the long-term results—because making your first million won't may not be easy but it doesn't need to be impossible.