Graduation is right around the corner and that diploma may not be the only piece of paper graduates are excited to receive. If you’re among them, it’s likely your family and friends are eager to celebrate your accomplishment, and you may be expecting some gifts in the form of checks or cash. As tempting as it may be to go out and spend this money right away, here are a few ways you may be able to put your graduation money to better use.
Begin Paying off Loans
While the stress of tests and papers will soon be off your mind, in comes the anxiety of having to repay those student loans. You’re not alone. Many students rely on loans to help them achieve their degree — the rising student loan debt is proof. Your graduation money may not be able to cover your entire loan, but it could be a good start. Since some loans accrue interest during the grace period, this money may be able to tide you over in the meantime.
There are many ways you can invest in yourself after your college graduation. For example, you can pay to speak with a professional like a financial planner or debt attorney. These professionals can help you determine your financial goals and help you sort out your student loans so you can begin the repayment process. Another great investment in yourself is to join a networking group. This can be an opportunity to meet industry professionals and begin making a name for yourself. Speaking of making a name for yourself, consider investing in some professional attire!
Build an Emergency Fund
You may also want to consider “paying yourself first.” Now may be a good time to start saving your money and begin creating the perfect emergency fund. Storing your money away in a savings account can give you time to decide how you would like to best spend your graduation money. Just be careful not to dip into this when you’re looking for quick cash, as you may deplete your savings before you have a chance to put the money to good use!
When starting out in the workforce, things may be uncertain. You may look to change jobs or pursue a different career. An emergency fund can keep you afloat while you’re figuring this out. Consider putting away at least three to six months worth of living expenses.
Consider using your graduation money to make even more money. Investing in mutual funds, stocks, an individual retirement account or other investment tools while you’re young gives your money more time to compound, which can mean even more money for your future! These funds can be used later to help make larger purchases such as paying for a wedding or making a down payment on a home. Before looking to build your portfolio, consider speaking with a financial planner who can place your money in places that align with your financial goals.
You may want to set aside some of that money to treat yourself. After all, you’ve worked hard to earn that diploma and there’s no harm in celebrating this accomplishment with a gift to yourself. Consider using some of your graduation money on a purchase or experience that will remind you of all your hard work in college. This isn’t to say you should blow all this money on a frivolous or impulsive purchase, but life’s accomplishments should be celebrated. Your college graduation is no exception.
No single investment strategy is right for everyone. As your goals change and you approach retirement, it’s wise to reconsider your current strategy to ensure it’s going to get you where you want to be.
Here are some of the best strategies for investing.
1. Balance Risk & Return
There are numerous investment options to choose from, each with different risks and different rates of return. Generally speaking, the higher the chance of making money, the higher the risk of losing some (or all) of your investment.
One example of a high-risk investment is a small startup company with a stock price that goes up and down significantly every week. Low-risk investments usually offer a more modest rate of return, but you could lose money to inflation over time. Low-risk investments often include bonds and stocks — also known as equities — in larger, more established firms like blue chip companies.
2. Diversifying Investments
Diversification is an important element in any investment portfolio, usually a mix of both high-return and low-risk investments. Mutual funds are an example of a diversified portfolio because your investment is spread across a broad mix of stocks and bonds. Growth-oriented funds represent a higher risk, but also a greater chance of growth. Bond funds represent a low risk and low growth. Balanced funds usually find harmony between the two.
3. Investing in the Early Years
For anyone just entering the workforce, Robert Johnson, CFA, CAIA and president of The American College of Financial Services, strongly recommends investing in stocks for a good rate of return.
“Simply put, the greatest advantage for an investor is time,” he says. “A person just entering the workforce should invest in the equity markets, as they provide the highest returns over a long period of time. While equity returns are highly variable, over time equity investors outperform bond investors by a wide margin.”
From his experience, Johnson says millennials are overly risk-averse and focus on savings rather than investing their money.
“This may seem like a subtle difference,” he adds, “but the difference has significant ramifications. When people save, they take little risk. When people invest, they take [more] risk.”
Despite the greater number of years they have to absorb risk and generate greater returns on their investments, Johnson says, millennials are actually more conservative than older generations.
4. Investing in the Retirement Red Zone
As you approach retirement, you can begin lowering risk in your portfolio by reducing the amount invested in equities and putting more money into fixed-income securities, Johnson advises. He compares the years just before retirement to the red zone in a football game.
“When one is within a few years of retirement — say five — they are entering the retirement red zone,” he explains. “Just as a football team can’t afford a turnover when inside the opponent’s 20-yard line, an investor can’t afford a turnover when they are within a few years of retirement.”
A recent example, Johnson says, would be someone who was due to retire after the 2008 stock market crash.
“If they were invested solely in a diversified S&P 500 index fund, they would have seen the value of their portfolio drop by 37%,” he says.
Regardless of what stage of life you’re in, a portion of your savings and investments should be quickly accessible in case of emergency. Racking up big debts will hurt your bank account and your credit. (You see where you currently stand by pulling your credit reports from each of the three major credit reporting agencies for free every 12 months at AnnualCreditReport.com and viewing two of your credit scores, updated every 14 days, for free on Credit.com.)
Chances are you’re like most Americans and, regardless of your age, you aren’t saving enough for retirement, if you’re actually saving anything at all.
Nearly 40 million U.S. households (45%) have no retirement assets, according to a recent report by the National Institute on Retirement Security, and half of those households are headed by someone aged between 45 and 65. In fact, savings rates are so bad that many Americans are dying with an average of $62,000 in debt.
Even if you are saving enough for retirement, you might still wonder if that money will last your entire lifetime. Defined contribution plans like 401Ks are great at helping employees save for retirement, but they provide no guarantee of income as pensions do. On top of that, most 401Ks are self-directed, meaning those who do a poor job handling their investments could end up with significantly less money than they need in retirement.
But what if you could guarantee yourself income for life, just like ubiquitous company pension plans used to provide (and government pension plans still do)?
Well, you can. Here’s how.
Back in 2014, the Treasury Department started an initiative focused on “putting the pension back” into 401K retirement savings. (Need to brush up on retirement lingo? Here’s a handy guide.) Through loosened restrictions and some tax-law changes, the Treasury made it easier to convert funds from retirement savings into plans known as longevity income annuities, or LIAs, that provide guaranteed lifetime income.
Income for Life
LIAs are deferred annuities and, while they’ve been for a while, they’ve only recently become a part of mainstream retirement planning. The Treasury initiative could even cause them to become an integral part of 401K target funds. Here’s how they work: Say you have $100,000 in retirement savings. At age 65, you use $10,000 of that money to purchase an LIA. “Even in the current low-interest-rate environment, a deferred single-life annuity purchased at age 65 for a male costing $10,000 can generate an annual benefit flow from age 85 onward of $4,830 ($3,866 for a female) per year for life,” a recent National Bureau of Economic Research working paper concluded.
It’s easy to see how helpful this kind of guaranteed income could be, particularly given larger investment amounts. Of course, it’s a hedge that you’ll live long enough to take advantage of those funds, but some programs provide for reimbursement should you die before accessing all of your money. More on that in a minute.
According to Olivia S. Mitchell, a professor at the Wharton School of the University of Pennsylvania and a co-author of the working paper mentioned above, LIAs are available to investors but are not yet tied to defined-contribution plans.
“There has been discussion about including them in the target-date suite of funds, and some employers are actively looking for options,” she said in an email. “Relatively few insurers have them available as yet.”
“One reason annuities or lifetime income streams are not a standard feature of 401K plans is that many people don’t understand these products,” she wrote in an article for Forbes. “For instance, some older individuals tend to underestimate their chances of living a long time, so they don’t take proper precautions against outliving their assets. Others don’t understand financial concepts, and so they’re reluctant to take unfamiliar financial decisions. After all, retirement is usually a once-in-a-lifetime event!”
Just because they aren’t directly tied to defined-contribution plans just yet doesn’t mean LIAs aren’t easily accessed. AARP, for example, has been offering its Lifetime Income Program through New York Life since 2006. AARP’s plan has a cash refund feature so, as we mentioned earlier, if you die before your payments equal your annuity purchase price, your beneficiary will be paid the difference.
Is an LIA Right for Me?
As with most financial tools, some people will benefit from an LIA more than others. “People in poor health might not want to elect deferred annuities, particularly if they have a poor survival prognosis,” Mitchell said. “Some very wealthy people will not need the LIA as they can self-insure against outliving their assets. Retirees with a (well-funded) defined benefit pension probably don’t need additional annuitization. And people with a very small nest egg might not find it worthwhile to annuitize, say, $10,000. But much of the middle class could benefit.”
In considering LIA plans, Mitchell recommends asking how highly rated the insurer is who provides it. She also suggests knowing how well the state insurance guarantee fund is being run and the maximum amount you’d recover should the insurer go bankrupt. (As you’re planning your retirement, you should also make sure you have a full picture of your finances, including your credit. You can get a free snapshot of your credit report on Credit.com.)
So how much should you consider putting into an LIA? “Older individuals would optimally commit 8% to 15% of their plan balances at age 65 to a LIA, which begins payouts at age 85,” Mitchell, et al, wrote in their working paper.
As for timing, it doesn’t really make sense for someone who isn’t at or near retirement age to purchase an LIA. For one thing, you can’t access your retirement funds without penalty until age 60.
“It makes sense to decide how much to devote to the LIA in your mid-60s, since that gives 20 years over which the annuity value can build up,” so you can begin taking payments at age 85, Mitchell said.
Of course, there are a variety of annuity products to suit different personal needs, such as earlier payout options, so it’s a good idea to speak with a financial professional who can help you decide what product might be best for your financial situation.
If you’re obsessed with HGTV, remodeling and regularly use phrases like “reclaimed wood” and “farmhouse feel,” you’ve probably kicked around the idea of buying investment property. The popular TV niche has given birth to a group of people who are motivated to improve their incomes with do-it-yourself projects and tenants in tow.
While it may seem simple and fulfilling on the small screen, buying rental property carries the same risks as purchasing your primary home. The following questions are some you’ll want to answer as you consider possible investment strategies.
1. What Are Your Financial Goals?
Are you hoping to earn extra monthly income, or do you view rental property as an attractive long-term investment? Being clear about your expectations is crucial to nailing down whether investment property is a wise choice. According to Mark Ferguson, Realtor, real estate investor and voice of InvestFourMore.com, many buyers fail to think beyond square footage.
“The biggest mistakes I see are investing in a property that loses money while hoping for appreciation, paying all cash for properties when you don’t have to and trying to manage (properties) yourself without skills or time,” Ferguson said.
It’s a good idea to make a list of short- and long-term goals as well as deal-breakers for any investment you choose. Creating rules will help you stay focused.
2. Can You Afford Extra Expenses?
Maintaining rental property takes work and extra cash, and while it’s tempting to focus on the best-case scenario, you shouldn’t discount the hefty expense of rental property taxes, association dues, management, maintenance and repairs. It’s possible to cut expenses by taking on a few handy projects yourself, but it won’t eclipse the costs entirely.
It’s wise to build a reserve fund in anticipation of your property’s needs according to Scott Trench, real estate broker and vice president of operations at BiggerPockets.com. “If you have $10,000, or even $20,000-plus in a bank account set aside for reserves, you can buy your way out of many problems associated with small rental properties,” Trench said.
With that in mind, you may want to consider building an emergency fund for your business investments in addition to your personal savings account. Separating your expenses is necessary for tax purposes, and you’ll need two accounts to maintain personal and professional independence.
3. Which Real Estate Market Is Right For You?
Although analysts predict a healthy rental market in 2017, value is still subjective, and you might consider looking outside your ZIP code to see if there are better buying options elsewhere.
“Certain metropolitan areas are most attractive to the country’s largest population groups—millennials and boomers — and are growing much faster than others,” said Alex Cohen, commercial specialist for CORE, a real estate brokerage firm based in New York City.
“Some of these markets have relatively low land and housing construction costs like Dallas and Houston. But other markets, particularly on the coasts, have much higher land and construction costs, which means less housing will be built in these metros,” Cohen said. “The flip side of this phenomenon is that in these housing-supply-constrained markets, values of homes and rents are likely to rise faster than in the rest of the country.”
While some experts suggest buying in up-and-coming locations, others swear that a good deal can lead to better returns and the ability to expand. “My 16 rentals have increased my net worth by over $1 million dollars through appreciation and buying cheap to begin with,” Ferguson said.
It’s a good idea to research all your options — from foreclosures to new construction — to determine which property could produce the best income and overall bang for your buck. Don’t be afraid to venture beyond your own backyard.
4. Are Your Finances & Credit In Good Shape?
If you are a homeowner, you may feel like a pro when it comes to applying for a mortgage, closing the deal and upgrading your property. While you may have some valuable experience, buying investment property comes with its own set of rules. Unlike purchasing your primary home, most rental mortgages require a larger down payment with a few exceptions.
“The way to minimize the additional costs — particularly higher down payment requirements of an investment property — is to take out an FHA loan, for which a down payment of as low as 3.5% of the purchase price may be possible,” Cohen said. “FHA loans are available to investors in properties with up to four units, as long as the borrower’s primary residence will be one of the apartment units.”
If you don’t plan to live in the rental property, you’ll need to secure a standard mortgage loan with a host of federal requirements that include financial reserves based on property value and the number of rentals you own, assets required to close and creditworthiness.
The latter requirement is perhaps the most important factor in securing an affordable investment. A high score will help you find the best interest rates and save money long before you decide to buy a rental home. It’s a good idea to order free copies of your TransUnion, Experian and Equifax reports from AnnualCreditReport.com to review your information. Highlight any negative items or errors that may be affecting your scores and consult with an expert about the best way to take action. You can also view two of your credit scores for free, updated every 14 days, on Credit.com.
Remember, whether you’re hitting up the housing market to invest or find your dream home, there are plenty of things you’ll want to do to get ready ahead of your search. Fortunately, we got a 50-step checklist for house hunters right here.
The Roth IRA versus traditional IRA debate has raged on for years.
What many retirement savers may not know is that most of the debate about whether it’s better to contribute to a traditional IRA or a Roth IRA is flawed.
You’ve probably heard that young investors are better off contributing to a Roth IRA because they’ll likely be in a higher tax bracket when they’re older. You’ve probably also heard that if you’re in the same tax bracket now and in retirement, a traditional IRA and Roth IRA will produce the same result.
These arguments are part of the conventional wisdom upon which many people make their decisions, and yet each misses some important nuance and, in some cases, is downright incorrect.
In this article we’re going to clear up the confusion and break down the traditional vs. Roth IRA debate the right way. Here’s what we’ll cover:
The Biggest Difference Between Traditional and Roth IRAs
There are several differences between traditional and Roth IRAs, and we’ll get into many of them below.
The key difference is in the tax breaks they offer.
Contributions to a traditional IRA are not taxed up front. They are tax-deductible, meaning they decrease your taxable income for the year in which you make the contribution. The money grows tax-free inside the account. However, your withdrawals in retirement are treated as taxable income.
Contributions to a Roth IRA are taxed up front at your current income tax rate. The money grows tax-free while inside the account. And when you make withdrawals in retirement, those withdrawals are not taxed.
Whether it’s better to get the tax break when you make the contribution or when you withdraw it in retirement is the centerpiece of the traditional vs. Roth IRA debate, and it’s also where a lot of people use some faulty logic.
We’ll debunk the conventional wisdom in just a bit, but first we need to take a very quick detour to understand a couple of key tax concepts.
The Important Difference Between Marginal and Effective Tax Rates
Don’t worry. We’re not going too far into the tax weeds here. But there’s a key point that’s important to understand if you’re going to make a true comparison between traditional and Roth IRAs, and that’s the difference between your marginal tax rate and your effective tax rate.
When people talk about tax rates, they’re typically referring to your marginal tax rate. This is the tax rate you pay on your last dollar of income, and it’s the same as your current tax bracket. For example, if you’re in the 15% tax bracket, you have a 15% marginal tax rate, and you’ll owe 15 cents in taxes on the next dollar you earn.
Your effective tax rate, however, divides your total tax bill by your total income to calculate your average tax rate across every dollar you earned.
And these tax rates are different because of our progressive federal income tax, which taxes different dollars at different rates. For example, someone in the 15% tax bracket actually pays 0% on some of their income, 10% on some of their income, and 15% on the rest of their income. Which means that their total tax bill is actually less than 15% of their total income.
For a simple example, a 32-year-old couple making $65,000 per year with one child will likely fall in the 15% tax bracket. That’s their marginal tax rate.
But after factoring in our progressive tax code and various tax breaks like the standard deduction and personal exemptions, they will only actually pay a total of $4,114 in taxes, making their effective tax rate just 6.33% (calculated using TurboTax’s TaxCaster).
As you can see, the couple’s effective tax rate is much lower than their marginal tax rate. And that’s almost always the case, no matter what your situation.
Keep that in mind as we move forward.
Why the Conventional Traditional vs. Roth IRA Wisdom Is Wrong
Most of the discussion around traditional and Roth IRAs focuses on your marginal tax rate. The logic says that if your marginal tax rate is higher now than it will be in retirement, the traditional IRA is the way to go. If it will be higher in retirement, the Roth IRA is the way to go. If your marginal tax rate will be the same in retirement as it is now, you’ll get the same result whether you contribute to a traditional IRA or a Roth IRA.
By this conventional wisdom, the Roth IRA typically comes out ahead for younger investors who plan on increasing their income over time and therefore moving into a higher tax bracket or at least staying in the same tax bracket.
But that conventional wisdom is flawed.
When you’re torn between contributing to a traditional or Roth IRA, it’s almost always better to compare your marginal tax rate today to your effective rate in retirement, for two reasons:
Your traditional IRA contributions will likely provide a tax break at or near your marginal tax rate. This is because federal tax brackets typically span tens of thousands of dollars, while your IRA contributions max out at $5,500 for an individual or $11,000 for a couple. So it’s unlikely that your traditional IRA contribution will move you into a lower tax bracket, and even if it does, it will likely be only a small part of your contribution.
Your traditional IRA withdrawals, on the other hand, are very likely to span multiple tax brackets given that you will likely be withdrawing tens of thousands of dollars per year. Given that reality, your effective tax rate is a more accurate representation of the tax cost of those withdrawals in retirement.
And when you look at it this way, comparing your marginal tax rate today to your effective tax rate in the future, the traditional IRA starts to look a lot more attractive.
Let’s run the numbers with a case study.
A Case Study: Should Mark and Jane Contribute to a Traditional IRA or a Roth IRA?
Mark and Jane are 32, married, and have a 2-year-old child. They currently make $65,000 per year combined, putting them squarely in the 15% tax bracket.
They’re ready to save for retirement, and they’re trying to decide between a traditional IRA and a Roth IRA. They’ve figured out that they can afford to make either of the following annual contributions:
$11,000 to a traditional IRA, which is the annual maximum.
$9,350 to a Roth IRA, which is that same $11,000 contribution after the 15% tax cost is taken out. (Since Roth IRA contributions are nondeductible, factoring taxes into the contribution is the right way to properly compare equivalent after-tax contributions to each account.)
So the big question is this: Which account, the traditional IRA or Roth IRA, will give them more income in retirement?
Using conventional wisdom, they would probably contribute to the Roth IRA. After all, they’re young and in a relatively low tax bracket.
But Mark and Jane are curious people, so they decided to run the numbers themselves. Here are the assumptions they made in order to do that:
They will continue working until age 67 (full Social Security retirement age).
They will continue making $65,000 per year, adjusted for inflation.
They will receive $26,964 per year in Social Security income starting at age 67 (estimated here).
They will receive an inflation-adjusted investment return of 5% per year (7% return minus 2% inflation).
At retirement, they will withdraw 4% of their final IRA balance per year to supplement their Social Security income (based on the 4% safe withdrawal rate).
They will file taxes jointly every year, both now and in retirement.
You can see all the details laid out in a spreadsheet here, but here’s the bottom line:
The Roth IRA will provide Mark and Jane with $35,469 in annual tax-free income on top of their Social Security income.
The traditional IRA will provide $37,544 in annual after-tax income on top of their Social Security income. That’s after paying $4,184 in taxes on their $41,728 withdrawal, calculating using TurboTax’s TaxCaster.
In other words, the traditional IRA will provide an extra $2,075 in annual income for Mark and Jane in retirement.
That’s a nice vacation, a whole bunch of date nights, gifts for the grandkids, or simply extra money that might be needed to cover necessary expenses.
It’s worth noting that using the assumptions above, Mark and Jane are in the 15% tax bracket both now and in retirement. According to the conventional wisdom, a traditional IRA and Roth IRA should provide the same result.
But they don’t, and the reason has everything to do with the difference between marginal tax rates and effective tax rates.
Right now, their contributions to the traditional IRA get them a 15% tax break, meaning they can contribute 15% more to a traditional IRA than they can to a Roth IRA without affecting their budget in any way.
But in retirement, the effective tax rate on their traditional IRA withdrawals is only 10%. Due again to a combination of our progressive tax code and tax breaks like the standard deduction and personal exemptions, some of it isn’t taxed, some of it is taxed at 10%, and only a portion of it is taxed at 15%.
That 5% difference between now and later is why they end up with more money from a traditional IRA than a Roth IRA.
And it’s that same unconventional wisdom that can give you more retirement income as well if you plan smartly.
5 Good Reasons to Use a Roth IRA
The main takeaway from everything above is that the conventional traditional versus Roth IRA wisdom is wrong. Comparing marginal tax rates typically underestimates the value of a traditional IRA.
Of course, the Roth IRA is still a great account, and there are plenty of situations in which it makes sense to use it. I have a Roth IRA myself, and I’m very happy with it.
So here are five good reasons to use a Roth IRA.
1. You Might Contribute More to a Roth IRA
Our case study above assumes that you would make equivalent after-tax contributions to each account. That is, if you’re in the 15% tax bracket, you would contribute 15% less to a Roth IRA than to a traditional IRA because of the tax cost.
That’s technically the right way to make the comparison, but it’s not the way most people think.
There’s a good chance that you have a certain amount of money you want to contribute and that you would make that same contribution to either a traditional IRA or a Roth IRA. Maybe you want to max out your contribution and the only question is which account to use.
If that’s the case, a Roth IRA will come out ahead every time simply because that money will never be taxed again.
If so, it’s a great way to give yourself some extra tax-free income in retirement, and you can only do it with a Roth IRA.
3. You Might Have Other Income
Social Security income was already factored into the example above. But any additional income, such as pension income, would increase the cost of those traditional IRA withdrawals in retirement by increasing both the marginal and effective tax rate.
Depending on your other income sources, the tax-free nature of a Roth IRA may be helpful.
4. Tax Diversification
You can make the most reasonable assumptions in the world, but the reality is that there’s no way to know what your situation will look like 30-plus years down the road.
We encourage people to diversify their investments because it reduces the risk that any one bad company could bring down your entire portfolio. Similarly, diversifying your retirement accounts can reduce the risk that a change in circumstances would result in you drastically overpaying in taxes.
Having some money in a Roth IRA and some money in a traditional IRA or 401(k) could give you room to adapt to changing tax circumstances in retirement by giving you some taxable money and some tax-free money.
5. Financial Flexibility
Roth IRAs are extremely flexible accounts that can be used for a variety of financial goals throughout your lifetime.
One reason for this is that your contributions are available at any time and for any reason, without tax or penalty. Ideally you would be able to keep the money in your account to grow for retirement, but it could be used to buy a house, start a business, or simply in case of emergency.
All in all, Roth IRAs are more flexible than traditional IRAs in terms of using the money for nonretirement purposes.
3 Good Reasons to Use a Traditional IRA
People love the Roth IRA because it gives you tax-free money in retirement, but, as we saw in the case study above, that doesn’t always result in more retirement income. Even factoring in taxes, and even in situations where you might not expect it, the traditional IRA often comes out ahead.
And the truth is that there are even MORE tax advantages to the traditional IRA than what we discussed earlier. Here are three of the biggest.
1. You Can Convert to a Roth IRA at Any Time
One of the downsides of contributing to a Roth IRA is that you lock in the tax cost at the point of contribution. There’s no getting that money back.
On the other hand, contributing to a traditional IRA gives you the tax break now while also preserving your ability to convert some or all of that money to a Roth IRA at your convenience, giving you more control over when and how you take the tax hit.
For example, let’s say that you contribute to a traditional IRA this year, and then a few years down the line either you or your spouse decides to stay home with the kids, or start a business, or change careers. Any of those decisions could lead to a significant reduction in income, which might be a perfect opportunity to convert some or all of your traditional IRA money to a Roth IRA.
The amount you convert will count as taxable income, but because you’re temporarily in a lower tax bracket you’ll receive a smaller tax bill.
Of course, there are downsides to this strategy as well. Primarily there’s the fact that taxes are complicated, and you could unknowingly cost yourself a lot of money if you’re not careful. And unlike direct contributions to a Roth IRA, you have to wait five years before you’re able to withdraw the money you’ve converted without penalty. It’s typically best to speak to a tax professional or financial planner before converting to a Roth IRA.
But the overall point is that contributing to a traditional IRA now gives you greater ability to control your tax spending both now and in the future. You may be able to save yourself a lot of money by converting to a Roth IRA sometime in the future rather than contributing to it directly today.
2. You Could Avoid or Reduce State Income Tax
Traditional IRA contributions are deductible for state income tax purposes as well as federal income tax purposes. That wasn’t factored into the case study above, but there are situations in which this can significantly increase the benefit of a traditional IRA.
First, if you live in a state with a progressive income tax code, you may get a boost from the difference in marginal and effective tax rates just like with federal income taxes. While your contributions today may be deductible at the margin, your future withdrawals may at least partially be taxed at lower rates.
Second, it’s possible that you could eventually move to a state with either lower state income tax rates or no income tax at all. If so, you could save money on the difference between your current and future tax rates, and possibly avoid state income taxes altogether. Of course, if you move to a state with higher income taxes, you may end up losing money on the difference.
3. It Helps You Gain Eligibility for Tax Breaks
Contributing to a traditional IRA lowers what’s called your adjusted gross income (AGI), which is why you end up paying less income tax.
But there are a number of other tax breaks that rely on your AGI to determine eligibility, and by contributing to a traditional IRA you lower your AGI you make it more likely to qualify for those tax breaks.
Here’s a sample of common tax breaks that rely on AGI:
Saver’s credit – Provides a tax credit for people who make contributions to a qualified retirement plan and make under a certain level of AGI. For 2017, the maximum credit is $2,000 for individuals and $4,000 for couples.
Child and dependent care credit – Provides a credit of up to $2,100 for expenses related to the care of children and other dependents, though the amount decreases as your AGI increases. Parents with young children in child care are the most common recipients of this credit.
Medical expense deduction – Medical expenses that exceed 10% of your AGI are deductible. The lower your AGI, the more likely you are to qualify for this deduction.
0% dividend and capital gains tax rate – If you’re in the 15% income tax bracket or below, any dividends and long-term capital gains you earn during the year are not taxed. Lowering your AGI could move you into this lower tax bracket.
Making a Smarter Decision
There’s a lot more to the traditional vs. Roth IRA debate than the conventional wisdom would have you believe. And the truth is that the more you dive in, the more you realize just how powerful the traditional IRA is.
That’s not to say that you should never use a Roth IRA. It’s a fantastic account, and it certainly has its place. It’s just that the tax breaks a traditional IRA offers are often understated.
It’s also important to recognize that every situation is different and that it’s impossible to know ahead of time which account will come out ahead. There are too many variables and too many unknowns to say for sure.
But with the information above, you should be able to make a smarter choice that makes it a little bit easier to reach retirement sooner and with more money.
Chicago, Ill.-based actor Mike Wollner says at ages 7 and 10 his daughters are already learning how to invest.
Three years ago, Wollner opened custodial brokerage accounts for the girls through Monetta Mutual Funds, which has a Young Investor Fund specifically for young people to invest for the future. Through the fund, parents can open custodial brokerage accounts or 529 college savings accounts on behalf of their children, as well as get access to financial education and a tuition rewards program.
Wollner decided to open the accounts once his daughters began to nab acting gigs and earn an income. They’re already beginning to understand what it means to own a part of the world’s largest companies. “They will ask me to drive past Wendy’s to go to McDonald’s and say, ‘well, we own part of McDonald’s,’” he says.
Wollner hopes his daughters will have saved enough for college by the time they graduate high school. His 10-year-old’s account balance already hovers around $13,000, while his 7-year-old has a little less than $10,000 saved for college in her account.
The Value of Starting Young
The Monetta Fund is only one example of a way to invest on a child’s behalf. The downside to using an actively managed investment account like the one Monetta offers is that it comes with higher fees — the fund’s expense ratio of 1.18% in 2016 is higher than the 0.10% – 0.70% fees typically charged by state-administered 529 college savings plans.
In addition to 529 plans, parents can open Coverdell Education Savings Accounts, or other custodial brokerage or IRA accounts through most financial institutions like Fidelity, Vanguard, or TD Ameritrade.
A college fund serves as a great way to teach kids a little about the time-value of money, but they’ll need to know more than that to manage their finances as well as adults.
“There’s no guarantee that they are going to be financially successful because anything can happen in life, but you’ll be better off with those skills and have a better chance of being successful with those skills than without them,” says Frank Park, founder of Future Investor Clubs of America. The organization operates a financial education program for kids and teens as young as 8 years old about financial management and investing.
He says FICA begins teaching financial concepts at an early age with hopes that the kids who start out with good money management habits now will continue to build on them as they age.
“If they fail to get that type of training now, it may be years into their late 20s, 30s, or 40s before they start. By then it could be too late. It could take 20 years to undo the mistakes they’ve made,” says Park.
3 Ways to Teach Young Kids About Money
Use real-world experiences
Wollner has each daughter cash and physically count out each check they receive from acting gigs.
“They just see a big stack of green bills, but that to a child is cool. It’s like what they see in a suitcase in the movies,” says Wollner.
He then uses the opportunity to teach how taxes work as he has his daughters set aside part of the stack of cash to pay taxes, union fees, and their agent.
“They start to see their big old pile of money diminish and get smaller and smaller,” says Wollner, who says the practice teaches his daughters “everything you make isn’t all yours, and I truly believe that that’s a lesson not many in our society learn.”
Kids don’t need to earn their own money to start learning. Simply getting a child involved with the household’s budgeting process or taking the opportunity to teach how to save with deals when shopping helps teach foundational money management skills.
Park urges parents to also share financial failures and struggles in addition to successes.
“They need to prepare their kids for the ups and downs of financial life so that they don’t panic if they lose their job, have an accident, or [their] identity [is] stolen,” says Park.
Gamified learning through apps or online games can be a fun way to spark or keep younger kids’ interest in a “boring” topic like investing.
There are a number of free resources for games online like those offered through Monetta, Education.com, or the federal government that aim to teach kids about different financial concepts.
Wollner says his youngest daughter benefited from playing a coin game online. He says the 7-year-old is ahead of her peers in fractions and learning about the monetary values of dollars and coins.
“This is how the kids learn. It’s the fun of doing it. They don’t think of it as learning about money, they think of it as a game,” says Bob Monetta, founder of Monetta Mutual Fund. The games Monetta has developed on its website are often used in classrooms.
When kids get a little older and can understand more complicated financial concepts, they can try out a virtual stock market game available for free online such as the SIFMA Foundation’s stock market game, the Knowledge@Wharton High School’s annual investment competition, or MarketWatch’s stock market game.
“The prospect of winning is what makes them leave the classroom still talking about their portfolios and their games,” says Melanie Mortimer, president of the SIFMA Foundation.
Anyone can play the simulation games, including full classrooms of students.
Aaron Greberman teaches personal finance and International Baccalaureate-level business management at Bodine High School for International Affairs in Philadelphia Penn. He says he uses Knowledge@Wharton High School’s annual investment competition in addition to online games like VISA’s websites, financialsoccer.com, and practicalmoneyskills.com, to help teach his high school students financial concepts.
Adults should play the games with children so that they can help when they struggle with a concept or have questions. Adults might even learn something about money in the process. Consider also leveraging mobile apps like Savings Spree and Unleash the Loot to gamify financial learning on the go.
Reinforce with clubs or programs
For more formal reinforcement, try signing kids up for a club or other financial education program targeting kids and teens.
FICA, the Future Investors Clubs of America, provides educational materials and other support to a network of clubs, chapters, and centers sponsored by schools, parents, and other groups across the nation.
When looking at financial education programs, it’s important to recognize all programs are not equal, says FICA founder, Frank Park.
“Generally speaking, you’re going to go with the company that has a good reputation of providing these services, especially if your kid is considering going into business in the future,” says Park.
The National Financial Educators Council says a financial literacy youth program should cover the key lessons on budgeting, credit and debt, savings, financial psychology, skill development, income, risk management, investing, and long-term planning.
Mortimer suggests parents also try getting involved at the child’s school by offering to start or sponsor an after-school investing club. She says many after-school youth financial education or investing organizations nationwide use SIFMA’s stock market simulation to place virtual trades and compete against other teams.
Whether you’re trying to pay off debt, top off your emergency fund or invest more, a little extra monthly income can get you there faster.
But there are only so many hours in a day — and maybe adding another side hustle to your busy schedule just isn’t possible. Wouldn’t it be great if you could somehow earn more without working additional hours or hitting up your boss for another raise? That’s what happens when you create passive income streams.
“Passive income’s great because it increases your cash flow and allows you to save [more],” says financial adviser Craig J. Ferrantino, president of Craig James Financial Services, LLC in New York. “The initial effort in some cases is minimal, and you have the ability to collect money on those efforts over a period of time.”
Of course, investing in the stock market can provide earnings over time through market returns and the magic of compounding. But there are also ways to create steady streams of passive income that pay out at regular intervals.
These efforts don’t come without risk. But with careful planning and consideration, you can lower the risks — and initial costs — and increase the potential benefits.
Here are six paths to passive income that may be worth pursuing.
1. High-Dividend Stocks
When you purchase stock in a company that pays dividends to its shareholders, you’ll start earning a percentage of the company’s profits automatically. For example, if a company pays an annualized dividend of 50 cents per share and you own 500 shares, you’ll get an extra $250 in your pocket—for doing nothing more than being a shareholder. (Most companies pay dividends on a quarterly basis, so you’d earn about 13 cents per share each quarter.)
Certain industries, like public utilities, financial services and oil, tend to pay higher dividends than others, so do your homework with resources like Yahoo! Finance’s stocks screener or by talking to an adviser.
“If you’re going after dividend income, the sweet spot is not the company that’s currently paying the highest yield, but the companies that are likely to generate growth in dividends in the coming months and years,” says Rob Brown, a Certified Financial Analyst and chief investment officer at United Capital. “Pay attention to what companies and industries are thriving now; they are most likely to raise the dividends they’re paying now in the future.”
You may also choose to reinvest your dividends, which allows you to buy more shares even without spending more money, so you can benefit more when the price rises.
One caveat: Remember that there are risks involved with investing in individual stocks—even ones with high-dividend yield—as the price of the stock can go up or down. You can lower your risk by investing in an index or other low-cost funds, which contains shares of many companies. One option is to look for dividend-paying ETFs, or exchange-traded funds, which are funds that trade like stocks.
Purchasing bonds can be another good way to earn consistent passive income, though the amount you’ll receive depends on the fluctuating bond market. “Bondholders [usually] receive a check every six months for the interest earned in loaning the entity money, and, in turn, get their principal back at maturity,” Ferrantino explains.
There’s a wide variety of bonds to choose from, including U.S. Treasury bonds, municipal bonds and corporate bonds. Each has its own maturity date, minimum investment, interest rate and payout. For instance, Treasury notes mature in two to 10 years and pay interest semiannually at a fixed rate (currently about 1% to 2%, depending on term lengths, and it is exempt from state and local taxes), while corporate bonds pay taxable interest and can have maturities ranging from a few weeks to 100 years.
Before purchasing bonds, make sure you know what you’re getting into—and what you will get out of it.
3. Rental Properties
Acquiring and maintaining rental property can require a lot more investment and sweat equity than other types of passive income, both upfront and over the years (if the roof leaks or the boiler breaks down in a rental property, you’re on the hook for it). But rental properties can also provide lucrative, ongoing income for many years to come.
“Rental properties in a market you understand can be a fantastic passive investment,” says Jeffrey Zucker, a seasoned angel investor and property management entrepreneur in Chicago. “I look for large or fast-growing housing markets, where people are clamoring for affordable, nice places.”
Before purchasing a rental property, Zucker recommends comprehensive due diligence to ensure that you can cover your costs—which likely include insurance, taxes and maintenance—and turn a profit on top of that. You want to invest in a property that will draw continued interest from renters and increase in value.
He also recommends using an experienced property manager. “There are some great property management companies out there that can assist to make leasing out rental properties truly passive mailbox money,” Zucker says. “Having managed our own properties for a few years prior to partnering with a company, we learned the long hours and effort that go into maintaining properties and dealing with tenants — and how much better those who focus solely on this role are at the job.”
4. Rewards Credit Cards
This might seem like an odd addition— and this is not a strategy to pursue unless you are able to pay off your bill in full each month. However, if you can use credit responsibly and avoid racking up debt, rewards credit cards can provide easy income, thanks to perks like cash-back bonuses. For instance, use a cash back credit card for all your household expenses — and pay it off at the end of the month — and you’ll earn money simply by making necessary purchases.
“My rewards have paid for a variety of travel experiences, and I have friends that use their points to pay exclusively for a certain [budget] category, like gas or household bills. It’s nice for them to cross an expense off simply by doing all of their planned spending on the right card,” Zucker says. “Be careful though, as many of the best rewards cards have high interest rates for any carry-over debt.”
5. Peer-to-Peer Lending
Also known as “marketplace lending,” peer-to-peer lending is the practice of individuals loaning money to others in place of a bank or other financial institution. In recent years, platforms like Prosper and Lending Club have made these crowdfunded loans more widely available to borrowers and opened the possibilities for investors.
“New, technology-driven intermediaries have been coming in and replacing banks to make small loans to businesses or individuals, and they offer many comparative advantages,” Brown says.
Remember, though, that while investing through a peer-to-peer marketplace can pay off, there are still risks involved and borrowers may default on their debts. One way to protect yourself, Brown says, is by requiring that borrowers’ credit quality is above a certain level, depending on your appetite for risk. You can also reduce risk by diversifying your investment across many different loans.
6. Renting Unused Space
The sharing economy is in full force, and if you have extra space in your home or spend a lot of time out of town, you can join in and earn some extra cash. Thousands of people are renting out their homes through Airbnb, and sites like Liquid Space and Breather offer opportunities to place your office or home up for rent during daytime hours. (Airbnb hosts renting a single room in a two-bedroom home cover, on average, a whopping 81% of their rent, according to one report.)
“Any unused space is an asset worth renting out if there is demand in your market,” Zucker says. “[Online marketplaces] offer consumers easy ways to make some extra money on rooms that would otherwise be doing nothing for them.”
Note: It’s important to remember that interest rates, fees and terms for credit cards, loans and other financial products frequently change. As a result, rates, fees and terms for credit cards, loans and other financial products cited in these articles may have changed since the date of publication. Please be sure to verify current rates, fees and terms with credit card issuers, banks or other financial institutions directly.
If you’re serious about long-term savings — whether for your retirement, your child’s college fund or both — you already know you need to do more than just save your pennies. You need dollars, and lots of them.
So, what if you could put a percentage of every purchase you make on your credit card into one of those investment funds? Would you do it? If your answer is yes, you may want to take a look at the Fidelity Rewards Visa Signature card from Fidelity Investments, because that’s exactly what this credit card does.
What Is the Fidelity Rewards Visa Signature Card?
The Fidelity Rewards card offers cardholders a very straightforward 2% back on all purchases, simple as that. Your reward is then deposited directly into a Fidelity account. For every $2,500 spent, a deposit of $50 is made into the investment account of your choice, and you can choose from a variety of accounts that meet your savings goals. Want your money deposited directly for retirement? Fidelity can put your 2% right into a traditional, Roth, rollover or SEP IRA. (Not sure what an IRA is? No worries: We have a full explainer on individual retirement accounts right here.) You can’t deposit directly into a 401K, however.
Prefer a brokerage account? No problem. For certain cardholders, there’s also the option of depositing your rewards into a 529 college savings account.
Of course, you can choose to spend your rewards instead of investing them, but the redemption value is lower if you choose to redeem your points for other rewards. The exact redemption rate varies, depending on how you cash in, a Fidelity spokesperson said. For instance, if you redeem rewards for retailer gift cards, the rate is .5% (10,000 points for $50 gift card).
No Spending Categories & No Limits
Not only does the Fidelity Rewards card making saving easy, there are no special spending categories and no limits or caps on the amount of rewards you can earn. Plus, the card’s variable 14.99% annual percentage rate means carrying a small balance every now and then won’t necessarily wipe out the rewards you earn. (Friendly reminder: It’s still important when using a rewards credit card to try your very best not to.)
New cardholders can get a $100 bonus after spending $1,000 in the first 90 days, but the funds must be deposited directly into a qualified Fidelity account. Qualifying accounts for both the regular rewards savings and signup bonus include:
Fidelity Cash Management Account
Fidelity-managed 529 College Savings plan
Fidelity Go account
The Fidelity Rewards card also comes with all the benefits provided through the Visa Signature platform, including:
Auto rental collision coverage. Rent your automobile with your Fidelity Rewards card and you can waive the rental agency’s collision coverage.
Emergency assistance while traveling. Find the help you need when you’re on the road.
Purchase protection. Extra coverage for the things you buy with your card, including reimbursement for damage or theft.
Warranty manager service. This service helps you keep track of the warranties on the items you purchase with your card.
Lost luggage reimbursement. This service covers lost or stolen baggage.
Travel accident insurance. This coverage will help if you’re injured while traveling.
Roadside dispatch. Need a tow? Locked yourself out of your car? This pay-per-use service offers many benefits, including emergency roadside assistance.
Visa Signature Concierge. Access to 24-hour complimentary assistance with everything from booking travel to getting concert tickets.
Is the Fidelity Rewards Visa Signature Card Right for You?
Even if you like the idea of of a card with no annual fee that lets you earn 2% on every purchase you make and then directly invests that money toward your savings goals, the Fidelity Rewards card isn’t for everyone. Here are a few things to keep in mind as you weigh your decision:
Do you have a Fidelity investment account? If you don’t, you’ll want to keep in mind that you can’t use your rewards as a deposit to establish a new Fidelity account. Rewards can only be deposited into existing accounts.
Do you have excellent credit? To qualify for the Fidelity Rewards card, you’re going to need excellent credit. If you don’t know what your credit score is, you can get your two free credit scores, updated every 14 days, right here on Credit.com using our free credit report snapshot. It provides personalized details on how you can improve your scores, including a timeline of how long it will take to do so, across five key areas affecting your credit scores. It also provides you with a personalized list of some of the credit cards you would qualify for.
Do you prefer investing over perks or cash back? If you travel a lot, whether for work or play, you might prefer some of the benefits that travel rewards cards offer, like free upgrades, free hotel stays, waived baggage fees and other non-monetary perks. Likewise, if you’d like more flexibility in what your rewards can be used for, a cash-back rewards card might be better for you.
Can you get higher rewards with another card? If you want more flexibility than the automated investing inherent with the Fidelity Rewards card allows, there are cards that offer higher rewards (for example, the American Express Blue Cash Preferred gives a whopping 6% cash back on up to $6,000 in purchases per year at U.S. supermarkets), so the automated investing aspect should be particularly important to you.
At publishing time, the American Express Blue Cash Preferred credit card is offered through Credit.com product pages, and Credit.com is compensated if our users apply and ultimately sign up for this card. However, this relationship does not result in any preferential editorial treatment. This content is not provided by the card issuer(s). Any opinions expressed are those of Credit.com alone, and have not been reviewed, approved or otherwise endorsed by the issuer(s).
Note: It’s important to remember that interest rates, fees and terms for credit cards, loans and other financial products frequently change. As a result, rates, fees and terms for credit cards, loans and other financial products cited in these articles may have changed since the date of publication. Please be sure to verify current rates, fees and terms with credit card issuers, banks or other financial institutions directly.
One of the golden rules of investing is not to have all of your eggs in one basket. This is pretty easy to do when you’re planning by yourself. It can get complicated when you are married. Should you both have the same investments or is it better to do something different?
Unlike combining checking accounts or getting a joint credit card, combining your investment goals and objectives with your spouse is a bit more complex. Legally, it is not possible to combine retirement accounts like a 401(k) or IRA. However, it is possible to align your retirement saving strategy. Typically these are the biggest investment accounts, and how you choose your investments will determine your level of financial freedom during retirement. Before you sit down with your spouse (possibly with help from a professional financial adviser) to determine how you can both approach your savings in order to maximize your joint benefit, it’s important to consider these things first.
Before you align your investments, start by aligning your investment goals
Before deciding on what investments you may need, you and your spouse should figure out your investment goals. If you’re around the same age, do you both plan on retiring at the same time? If there is a significant gap in age, there is a chance that one of you could be working much longer than the other, and your investments should reflect that.
A common example could be shown with target-date funds (TDFs). Currently, TDFs are offered by 70% of 401(k) plans, and they give investors the ability to invest according to the year they plan on retiring. Someone planning to retire in 2040 would choose the 2040 target-date fund. If you and your spouse are the same age, it would be OK to invest in the same TDF. But if one of you is choosing to retire in 2040 and the other in 2030, it may be in your best interest to choose funds that correspond to your individual goals instead.
Even if you don’t choose TDFs, your investment choices should be based primarily on your tolerance for risk and the amount of time you estimate working before you retire (also known as time horizon). If you and your spouse have different risk levels, then you should definitely have different investments.
If the younger spouse earns significantly less income, this presents a special challenge best left to a financial planner. A discrepancy in income would directly affect the amount you’re able to save and how it is allocated. In some cases you may have to adjust your allocation to compensate. Again, because there are several individual factors which could affect your investment decisions in this specific situation, you will want the guidance of a financial planner.
Understand diversification and asset allocation
The concepts of diversification and asset allocation are the cornerstones of sound investing. By diversifying your assets, you are spreading out your risk over several different types of assets, rather than simply owning one or two. This is why mutual funds have become extremely popular. Because mutual funds consist of a broad range of investments across the stock and bond market, they provide instant diversification. But it may not be necessary or helpful for you and your spouse to own different mutual funds in hopes of diversifying yourselves even more.
Sometimes it is best to keep things simple. You and your spouse could own the same investments but in different proportions.
For example, the two of you may decide to own Mutual Fund A, which is made up of stocks, and Mutual Fund B, which is made up of bonds. Because you’re older and more conservative, you may choose to invest in a portfolio that is split down the middle: 50% in Mutual Fund A and 50% in Mutual Fund B. Your spouse, especially if they are much younger, may choose a more risky asset mix, investing in a mix of 75% Fund A and 25% Fund B. Both of you would still own the same investments but own different amounts due to your preference for risk.
Additionally, if you invest consistently in funds from the same investment firm, such as Franklin Templeton Investments, MFS, or American Funds, you could qualify for discounts after investing a certain amount called breakpoints. Most companies will charge you a percentage to invest in the fund. For example, if you invest $10,000 consistently every year, you could be charged 2.25% or $225. When you hit a breakpoint, however, the fee goes down. After 10 years, you’ve invested $100,000 and anything you put in after this point will be 1.75%. Instead of paying $225 on every $10,000 you invest each year, you would now pay $175 until you hit the next breakpoint. Every company has their own breakpoint levels and fees they charge, which can vary wildly depending on the type of fund and philosophy of the company.
Most experts agree that it is better to choose a few mutual funds with one fund manager and take advantage of the breakpoints rather than choose one fund from several different managers. Using more than one manager can also make it more difficult to track your investment performance.
The Bottom Line
If you and your spouse are the same age and plan to retire around the same time, you should be OK holding the same investments, assuming they are solid investment choices. But if your age difference is more than three years, this should be reflected in your separate portfolios.
Inquiring about your path to retirement is one of the most important financial questions out there. Every year thousands of Americans are polled, and the overwhelming majority are worried about being on track for retirement or running out of money in retirement. According to Prudential’s 2016 Retirement Preparedness Survey, for 59% of current retirees, “not running out of money” in retirement is on the top of their priority list. Among those who are still approaching retirement, about one in four Americans are worried about not having enough money, with millennials leading the pack at at 29%.
There also seems to be a huge disconnect between our fears around money and the confidence in our ability to remedy those issues. Seventy-one percent of people consider themselves capable of making wise financial decisions, but only 2 in 5 don’t know what their money is invested in. Couple that with the fact that 25% of Americans have less than $1,000 in retirement savings, it is clear to see that we’re overconfident and underprepared.
While there isn’t a wealth of information as to why we’re so confident with our money, a part of the problem is not knowing where to start, not feeling like there is enough money to invest for retirement and paying down debt.
Some estimates say you’ll need as much as $2.5 million to retire comfortably, while the average 401(k) account balance is just $96,000, according to Vanguard. The truth is there is no one-size-fits-all figure. The number you need to retire comfortably depends heavily on when you plan to retire, your cost of living, your health, and how long you live in retirement. Additionally, those living in rural areas usually don’t need as much as those in metro area.
Here are a few ways to figure out how much you need and to check if you’re on track.
1. Do the math
Retirement planning calculators can get pretty complex, but to simply find out if what you have saved already is on par for what you will need in the future, there are some very easy calculations that you can use. One popular way to see if you’re on track is by using retirement benchmarks.
Using the chart below from JPMorgan is pretty straight forward. If you’re 35 years old with a household income of $75,000, you should have a total of $120,000 invested today. These charts, however, aren’t perfect because the underlying assumptions can vary wildly.
This chart from Charles Farrell, author of Your Money Ratios, suggests at 35-year-old making $75,000 per year should have $67,500 saved. This is $52,500 less than the JPMorgan chart shown earlier. This is because different models use different assumptions about how much your investments may grow, how much you continue to save, and at what age you plan to retire.
The JPMorgan chart assumes you will only save 5% per year versus 12% in Farrell’s model. Also when comparing both charts JPMorgan would have you on pace for saving just 8.4 times your salary versus 12 times your salary; a difference of $270,000. No benchmark is perfect. These estimates are meant to provide a quick assessment to let you know if you’re on the right track in terms of how much you have invested. They do not suggest which investments you should be holding.
2. Use a retirement calculator
In addition to doing the math yourself, there are some free tools to check your progress to retirement. Fidelity has a calculator that works very similar to the Charles Farrell mode, which gives you a factor that you need to have saved. Using the same example of a 35-year-old making $75,000, Fidelity’s calculator suggests having 2 times their salary, or about $150,000.
It is worth noting that Fidelity’s assumptions of how they reached this figure were not on the site, but by age 65 they suggest having a factor of 12 times your salary saved.
The Vanguard Retirement Nest Egg Calculator takes a different approach. Instead of taking your age and spitting out the amount you should have saved, this calculator asks you your current savings and investment allocation and gives you a prediction of whether your money will last or not. This is done by using what is called a Monte Carlo simulation. Vanguard tests the factors 5,000 times by changing different variable such as investment performance and cost of living.
Keeping all factors the same, someone who has saved $900,000 (which is 12 times their annual income of $75,000) would have a 50% chance that their money would not run out in 30 years.
Again, it is always important to consider the assumptions. In this calculator Vanguard is assuming you’re investing 20% of your money in stocks, 50% in bonds, and 30% in cash (indicated in the pie chart). This highlights the importance of asset allocation and its effect on your investment success. When we change the allocation, the success rate changes as well.
In this example, by reducing the cash from 30% to 10% the chances of success increased to 68%. Vanguard also assumes you’re withdrawing 5% of the portfolio per year, meaning that from the $900,000 you saved, you should be spending $45,000 of it each year.
If you were to increase or decrease this number, the chances of your money surviving would change as well.
By changing the withdrawal rate by just 1% to $36,000 per year, the probability shoots up to 92%. Most experts agree that a 4%-5% withdrawal rate is standard; what you decide to withdraw depends on what amount of money you think you can live off of at that point in time.
Finally, SmartAsset’s retirement calculator takes somewhat of a combined approach from the previous two we covered. Their calculator runs a Monte Carlo simulation like Vanguard and also takes into account what you’re currently making and when you want to retire, like Fidelity and JPMorgan. What makes SmartAsset’s calculator stand out, however, is that it takes into account your current location, monthly savings, and marital status. If you are falling short of your goal, the calculator tells you how much you need to save to catch up.
Meet with a financial planner
Finally, you can seek professional advice. Financial planners will take your investments, savings rate, and several other factors and show you if you’re on track. Additionally, a financial planner may also suggest better investments to get you closer to your goals.
Many banks and brokerage firms will run a comprehensive financial plan with no cost if you’re a customer. Independent financial planners may charge from $1,000 to $2,500 for a plan. Many people believe independent financial planners go more into depth with their analysis versus those who work in a bank. But it really comes down to a matter of preference, how well the person listens to you, and if they have your best interest as their top priority.