Getting Going
WITH THE ADVANTAGE of advanced age and flawless hindsight, I now believe the three most important contributors to retirement prosperity are a robust savings rate, an aggressive allocation to stocks and funding tax-free accounts, both Roth and health savings accounts (HSAs).
What about other financial factors, such as the investments we pick, whether we buy income annuities, when we claim Social Security and what Medicare choices we make? These matter on the margin, but I don’t think they’re as crucial to a successful retirement.
My three key contributors to a financially comfortable retirement are, I believe, especially critical in our early adult years. At that juncture, young earners have a long runway to capture the benefits of compounding, an aggressive stock allocation comes with relatively little risk and their low marginal tax rate makes tax-free accounts particularly appealing.
Save big early. I’d argue that the FIRE movement—financial independence, retire early—promotes a level of frugality that’s too extreme and that its “retire early” concept is unnecessary for most folks. The usual recommended savings rate of 10% to 20% of income is far more palatable than FIRE’s 50% to 70%.
Still, FIRE’s emphasis on saving early in life is spot on. My children’s small Roth contributions when they were 15-years-old will likely deliver more bang for their retirement buck than maxing out their 401(k) contributions at the end of their career. Similarly, a number of my wife’s and my early investments, made during the 1970s and 1980s, are now 20-baggers or more.
We tend to zero in on our retirement finances during our later working years, as we approach retirement. At that point, we also often have ample discretionary income to ramp up savings. The 401(k) and 403(b) rules even allow extra contributions after age 50, appropriately named “catch-up” contributions. But while such late-stage savings are good, incrementally higher savings rates during the first 30-years are a far more powerful contributor to investment compounding.
Go all stocks. Along with paying off personal debt, establishing an emergency fund and purchasing a primary home, those in their 20s, 30s and 40s also focus on stashing their savings in stocks and bonds, with an eye to reaping the rewards of compounding.
Stocks are clearly more volatile than bonds, but I’d argue they aren’t very risky if we’re investing for the longer-term. In fact, stocks are undefeated over 20-year time horizons and have always scaled investors’ “walls of worry.” This is nicely reaffirmed by financial writers Nick Maggiulli and Sam Ro.
Over our lifetime, we’ll encounter financial risks that can be more damaging than the occasional bear market, including decades of inflation, a surprisingly long retirement, health issues, getting laid off, forced early retirement, increased tax rates and all sorts of family challenges.
My contention: Young workers should maintain an aggressive tilt toward stocks, preferably using index funds, and even consider a 100% stock allocation if they can stomach the volatility. As Teddy Roosevelt once stated: “Old age is like everything else. To make a success of it, you’ve got to start young.”
Fund Roths and health savings accounts. We boomers didn’t have Roths or HSAs until the end of our careers, plus the Roth IRA’s income limits often stymied our ability to play. By contrast, today’s younger workers can profit by funding these tax-free accounts during their career’s early low tax-rate years. Roth accounts are winners when retirement tax rates end up being higher than those during the contribution years.
Today, 90% of workplace savings plans offer a Roth option, plus individuals can fund Roth IRAs up to $7,000 a year if they fall below the income thresholds. Meanwhile, more than 50% of employer benefit plans offer HSAs, the only savings vehicle that offers both tax-deductible contributions and tax-free withdrawals.
Over our lifetime, many of us suffer tax-bracket creep. Like me, retirees are often surprised to discover that their marginal tax rate easily exceeds their tax rate early in their career, especially once required minimum distributions start. On top of this, government deficits are growing and Social Security will require additional funding, so there’s a decent chance that tax rates will climb.
For those in the workforce, if tax rates rise or their own marginal rate increases, they can always redirect new savings from Roth accounts to traditional, tax-deductible retirement accounts. What if their tax rate declines once they retire? They can again look at funding Roth accounts, but this time via Roth conversions.
For today’s retirees, it may be too late to take advantage of the above three strategies. But we can still promote these strategies to our children and grandchildren, and maybe even help fund their accounts. Do your adult children need financial guidance to help them get going? Here are four websites I like: OfDollarsandData, AffordAnything, YoungMoney and Kyla’s.
John Yeigh is an author, coach and youth sports advocate. His book “Win the Youth Sports Game” was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles.The post Getting Going appeared first on HumbleDollar.
