Do you want to retire comfortably? How can you start preparing for retirement early?<\/p>\n\n\n\n
Retirement isn\u2019t something that just magically happens. You have to be dedicated to creating a financially stable situation for yourself years down the line when you stop working. Thankfully, the steps to retirement aren\u2019t that hard.<\/p>\n\n\n\n
Let\u2019s look at how to prepare for retirement in five steps.<\/p>\n\n\n\n\n\n\n\n
The first step to learning how to prepare for retirement is to start saving money<\/a> so you have enough to live comfortably in the future. Many people can\u2019t build a stable income for retirement because they live a high-consumption lifestyle relative to their income\u2014they spend whatever they make and therefore have no money to save and invest.<\/p>\n\n\n\n According to The Simple Path to Wealth<\/em><\/a> by JL Collins, high-income people have trouble making ends meet or they go broke by overspending. Many people think of money in terms of what it can buy<\/strong>. If your goal is achieving financial stability for retirement, you need to think of money in terms of what it can earn<\/strong>. With this mindset, even lower-income earners can retire comfortably by limiting their spending and investing whatever they don\u2019t need for expenses.\u00a0<\/p>\n\n\n\n Even if you overspent in the past, it\u2019s never too late to start thinking differently about money and how to use it. Spend less than you make, invest the extra, and stay out of debt\u2014and retirement won\u2019t be hard to achieve.<\/p>\n\n\n\n Collins doesn\u2019t argue that you should never<\/em> spend money, just that you should understand all the implications when you do\u2014including the opportunity cost<\/a>, which is what you give up when you choose one thing over another.<\/p>\n\n\n\n For example, if you spend $20,000 cash for a car, your opportunity cost\u2014what you give up by choosing to spend $20,000\u2014is the interest or dividends the money could have earned had you invested it. If you invested $20,000 in the VTSAX index fund, it would earn $1,600 a year or about 8%. That\u2019s your opportunity cost for the first year; over 10 years, because of compounding, you\u2019d miss out on earnings of $16,000 (the amount would have been higher had you reinvested your earnings each year).<\/p>\n\n\n\n Similarly, if you take out a car loan and have to make payments for five years, the opportunity cost is not having that money available to invest monthly and build wealth<\/a>. However, once you become financially independent<\/a>, compounding keeps your nest egg growing while you withdraw 4% a year to spend\u2014so spending has little opportunity cost. <\/p>\n\n\n\n One of the best ways to save money and prepare for retirement is to make a budget each month to determine where your money will go. If you don\u2019t, it will just disappear.<\/p>\n\n\n\n Here are the basic steps for creating a budget that The Total Money Makeover<\/em><\/a> by Dave Ramsey recommends:<\/p>\n\n\n\n The next step in learning how to prepare for retirement is deciding on your retirement plan, where you\u2019ll benefit most from compound interest. The earlier you invest, the more your money will grow, and the better off you\u2019ll be once you stop working.<\/p>\n\n\n\n In The Automatic Millionaire<\/em><\/a>, David Bach argues that you need to contribute to your retirement account before<\/strong> you pay your taxes to make the most out of your income. This is because the government takes approximately 30 cents per dollar of your salary as tax before the money is even sent to your checking account. This means that, if you intend to contribute 10% of your income towards your retirement, the amount you end up contributing after<\/em> you pay your taxes is considerably lower than the amount you\u2019d contribute before<\/em> you pay your taxes.\u00a0<\/strong><\/p>\n\n\n\n You can legally bypass the government\u2019s taxation to maximize the earning potential of your retirement fund and get the most out of your earned dollars by using a tax-deferred retirement<\/a> plan<\/strong>\u2014a plan that allows you to send money to your retirement account without having to pay tax on it.\u00a0<\/p>\n\n\n\n Bach suggests various retirement plans depending on whether you\u2019re employed by a company, or self-employed.<\/p>\n\n\n\n There are two types of self-directed retirement accounts your employer might offer: 401(k) and 403(b)<\/strong>. According to Bach, one out of every four American workers doesn’t sign up for the retirement accounts their companies offer\u2014he claims that most people just assume that they\u2019re automatically signed up to benefit from their company\u2019s retirement plan. <\/p>\n\n\n\n If your employer doesn\u2019t offer self-directed retirement accounts, you\u2019ll need to open an Individual Retirement Account (IRA). You can choose from one of three options: the Traditional IRA<\/a>, the Roth IRA<\/a>, or the Roth 401(k)<\/a>, which is similar to the Roth IRA but allows you to contribute more each year. The difference between the Traditional IRA and the Roth IRAs is when<\/em> you pay tax on your retirement money: when you withdraw money in the case of the Traditional IRA, and when you contribute in the case of the Roth IRAs. This means that the Traditional IRA has the benefit of allowing you to contribute more money upfront, as it won\u2019t be taxed. Meanwhile, the Roth IRAs provide tax-free income after you retire.<\/p>\n\n\n\n Business owners can take advantage of many different types of retirement accounts and benefit from many tax breaks. Bach claims that the simplest options to choose from are: the Simplified Employee Pension (SEP-IRA) and the One-Person 401(k) Profit Sharing Account, otherwise known as the \u201cSolo 401(k)\u201d.<\/p>\n\n\n\n You also need to get rid of your debt when learning how to prepare for retirement. The debt snowball<\/a> method from The Total Money Makeover<\/em><\/a> is the best way to pay off debt. It\u2019s easy to understand, but it takes effort and commitment to pull it off. There are two steps:<\/p>\n\n\n\n 1) Make a list of your debts, in order from the one with the smallest balance to the largest<\/strong>. Exclude only your mortgage, which will be addressed in another step. A form is available for downloading<\/a>.<\/p>\n\n\n\n 2) Each month, apply every extra dollar you have to the smallest debt until it\u2019s paid off. <\/strong>Make the minimum payment to stay current on all other debts.<\/p>\n\n\n\n After the smallest debt is paid, apply the payment you had been making on it, plus any additional money you have, toward paying off the next smallest debt. When the second debt is paid off, apply the payment amounts from the first two debts, plus any other money you can find, to the third debt on your list, and so on.<\/p>\n\n\n\n Each time you pay off a debt, you increase the amount you can pay on the next one\u2014your payments continue to snowball until your debts are paid off. <\/p>\n\n\n\n Starting with the smallest debts gives you some quick wins to motivate you, and by the time you get to the largest payments, such as car payments and student loans, you\u2019re in a position to pay over $1,000 a month. You\u2019ll soon be debt-free.<\/p>\n\n\n\n To make a debt snowball work, you need to create a monthly budget, be current on your loan payments before starting the process, and list your debts from smallest to largest. You need to make two mindset adjustments as well:<\/p>\n\n\n\n 1) Focus intensely on becoming debt-free:<\/strong> If you\u2019re half-hearted, the debt snowball won\u2019t work. Tell yourself, \u201cI\u2019m getting out of debt, no matter what.\u201d Fully focusing your mind on a goal is as powerful as focusing the sun\u2019s rays with a magnifying glass and setting a piece of paper on fire.<\/p>\n\n\n\n Develop gazelle-like intensity: a gazelle keeps an intense eye on its surroundings to avoid being taken down by a cheetah. Similarly, your focused attention on your finances will save you from debt<\/strong>. <\/p>\n\n\n\n 2) Stop using credit:<\/strong> While you’re working through your debt list, remember that your goal is to eliminate all debt\u2014don\u2019t replace any paid-off debts with new debt. Pledge that you\u2019ll never borrow money again<\/strong>. Before long, you\u2019ll face a test of your gazelle intensity level\u2014you\u2019ll need a major car repair or get the urge to make a big purchase using credit. To eliminate temptation, cut up your credit cards. You can\u2019t get out of your debt hole by digging it deeper.<\/strong><\/p>\n\n\n\n Many people rely on their Social Security before or after retirement. When you should start collecting Social Security<\/a> checks depends on your age and financial situation, according to The Simple Path to Wealth<\/em><\/a>.<\/p>\n\n\n\n The Social Security system has been sustainable in the past, but as large numbers of Baby Boomers retire and live longer, the payroll taxes that support it will fall short of payouts if nothing is done to fix it.<\/p>\n\n\n\n Thus, depending on your current age, your experience with Social Security likely will vary. Collins argues that:<\/p>\n\n\n\n If you\u2019re 55 or older, you\u2019ll collect the full amount you\u2019re entitled to <\/strong>because politicians won\u2019t take anything away from such a large group of voters. That\u2019s why the solutions proposed so far to shore up the system only affect those 55 and under.<\/p>\n\n\n\n If you\u2019re under 55, you won\u2019t get the same deal, but you\u2019ll still receive benefits. <\/strong>You can expect that:<\/p>\n\n\n\n Social Security is a good deal for most people over 55. Of course, if you invested the 6.2% of your income that goes to social security and the 6.2% your employers contribute, you\u2019d be better off financially in later years. But many people don\u2019t save or invest for retirement, so Social Security will keep them out of poverty in their last years.<\/p>\n\n\n\n Before diving into full-time retirement, it\u2019s a good idea to test the waters first. The best way to do that is to have mini-retirements<\/a>. A mini-retirement is a months-long hiatus from work during which you live one of your dreams. <\/strong>Unlike traditional retirement, you can have many periods of mini-retirement throughout your life.<\/p>\n\n\n\nThink About Opportunity Costs<\/strong><\/h3>\n\n\n\n
Make a Budget<\/strong><\/h3>\n\n\n\n
\n
Step 2: Start Investing ASAP<\/strong><\/h2>\n\n\n\n
If Your Employer Offers Self-Directed Retirement Accounts<\/strong><\/h3>\n\n\n\n
If You Need to Open an Individual Retirement Account <\/strong><\/h3>\n\n\n\n
If You\u2019re Self-Employed <\/strong><\/h3>\n\n\n\n
Step 3: Downsize Your Debt<\/strong><\/h2>\n\n\n\n
Tips for Success<\/strong><\/h3>\n\n\n\n
Step 4: Draw Social Security<\/strong><\/h2>\n\n\n\n
\n
Step 5: Test Out Mini-Retirements<\/strong><\/h2>\n\n\n\n