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Retirement saving is a long-term plan to set aside and invest money to provide income after you stop working. It often involves contributing to accounts like 401(k)s or IRAs. Starting early helps savings grow through compound interest. Understanding these five basics could help you make decisions to support your financial goals. A financial advisor can also work with you to create a retirement plan.
Determining how much to save for retirement is where planning for your financial future begins. The amount you need to save depends on several factors, including your desired lifestyle, expected retirement age and life expectancy. Many financial experts recommend setting a goal to replace about 70% to 80% of the income you earn just before you retire to maintain your accustomed standard of living. This percentage can vary based on personal circumstances, such as healthcare needs and travel plans, so savings goals are tailored to individual situations.
A good place to start is by estimating annual expenses in retirement. Consider costs such as housing, healthcare, food and leisure activities. Once you have a rough estimate, multiply this figure by the number of years you expect to be retired. This will give you a ballpark figure for your total retirement savings goal.
Don’t forget to account for inflation, which erodes purchasing power over time. Using a retirement calculator can help you adjust for these variables and provide a more accurate savings target.
Each type of retirement account offers specific benefits and potential drawbacks. Choosing the right one depends on your financial goals and circumstances. Here are four common types and their key characteristics:
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Traditional IRA: Contributions to a traditional IRA are usually tax-deductible, which can lower your taxable income for the year. The funds in the account grow tax-deferred, meaning you won’t pay taxes on the earnings until you withdraw them during retirement.
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Roth IRA: Contributions to a Roth IRA are made with after-tax dollars so they are not tax-deductible. However, they have another significant benefit, namely, that qualified withdrawals during retirement are tax-free. Having retirement savings in a Roth IRA can be particularly advantageous if you expect to be in a higher tax bracket in retirement.
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401(k) Plans: These plans are sponsored by employers and allow employees to contribute a portion of their salary pre-tax, reducing taxable income. Many employers also offer matching contributions to 401(k) plan participants, effectively providing free money to boost your retirement savings.
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SEP and SIMPLE IRAs: Self-employed individuals and small business owners can use SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs to accumulate retirement savings. SEP IRAs allow employers to make tax-deductible contributions on behalf of their employees, with higher contribution limits than traditional IRAs.
