How Much Should I Have In Retirement Savings At My Age?

Fidelity, a major player among 401(k) providers, announced new age-based savings guidelines last week. These benchmark values are intended to help workers stay on track for retirement, and are welcome in a world where the majority of Americans are responsible for saving for retirement on their own, with very little guidance.

According to the Fidelity guidelines, you should have 1x your annual salary at age 35, 3x at age 45, 5x at age 55, and 8x your salary in savings at retirement in order to retire on 85% of your salary. But is that enough?

The Fidelity calculation solves for an 85% income replacement ratio, which I think is fairly accurate for most people. Remember that you won't be saving for retirement anymore, which frees up a chunk of your income. In this hypothetical simulation the worker will being contributing at age 25, work and save continuously until 67, and live to age 92. The market returns used are 5.5%, and it assumes that the employee’s income rises 1.5% over inflation every year.

However, this simulation also assumes that you will collect social security immediately upon retirement, and I wouldn't bet on that. My guess is that our generation won't be able to access social security until age 70 or 75, which is actually more in line with the program's design. The problem with delayed social security income is that your early retirement income needs are likely higher than those in later retirement because that's when you are healthy enough to travel and enjoy expensive hobbies. So let’s assume that your first 5 years of retirement are funded solely by your retirement savings. If you retire with 8x your last year’s salary in savings, and in the first year you withdraw the equivalent of 85% of your salary, your withdrawal rate is over 10% a year! That is way too high. In other words, 8x your salary at retirement is not enough. 

Think of it this way: If your ending salary is $100,000, you would be aiming for a final balance of $800,000. Out of that, you would pull $85,000 the first year. That's 10.5%! I would never let a client head into retirement with that distribution plan.  I understand that the purpose of this study is to get Americans to save more (the average Fidelity 40(k) balance is $73k), but it seems to me that their benchmarks are way too low. 

Based on my calculations, the numbers should read as follows:

Age 35- 1.25x salary

Age 45- 3.5x salary

Age 55- 7x salary

Age 67- 14x salary

At 1.5% income growth, your $62,000 salary would be $100,000 at age 67, which means you would want at least $1.4 million in savings at retirement. You can then pull out $85,000 a year and still keep the withdrawal rate to 6%. This would still be a high withdrawal rate if you were planning to only withdraw from your savings, but as I mentioned earlier I do believe that social security benefits will kick in at some later point in our generation's retirement.

While benchmarks can be helpful, there are many problems with judging whether your retirement is on track by the balance at a particular point in time. It may give you a false sense of security. Two people, one who turned 35 in 2007 and the other in 2009, would have very different ideas about their retirement readiness. Another problem is that, for most people, life refuses to be linear. You may have to cut your savings during child-raising years, upon starting a new business, or during a lay-off. Finally, remember that everyone’s situation is different. A doctor who graduates medical school at age 30 with $200,000 in student loans will have a difficult time reaching those early targets, but will be able to contribute far more in the future.

Instead of your retirement account balance, focus on your savings rate. This is the area in which you have the most control. Aim to put away a total of 15% of pay (including your employer match) toward retirement each year. If your employer matches 3% of your salary, this means that you should contribute 12%. The Fidelity study actually builds up to a 15% savings rate (including employer contribution) by age 35. I actually recommend saving a portion of those funds in a Roth IRA if you qualify, so your 15% retirement contributions may look more like 5% Roth IRA, 7% 401(k), 3% employer match. If you are self-employed, pull out 15% of each check before you can spend it (as you should be doing with the taxes you will owe at the end of the year). In order to get to the 14x salary you will have to increase your retirement contributions to 20% for the last ten years of employment, which is typical for families who are able to ramp up retirement savings once the kids are through college.

Since not everyone can afford to contribute 15% right off the bat, many workers (myself included) may not get to 1.5x salary by age 35. In this case you will need to increase your savings rate a little higher to get on track. For instance, you may pay off a credit card or student loan and redirect those funds towards retirement savings. However, I wouldn't recommend lowering your contributions below 15% (again, including what your employer puts in) even if you are on track to hit the benchmark number earlier. 

You may choose to diversify your savings into different investment vehicles such as rental properties or alternative investments. Just keep in mind that 15% of your income goes into SOME sort of savings or investment vehicle every year. If you have 1.25x your current salary at age 35 and you continue to save 15% of your income, you will be on track to retire with 85% income replacement at age 67.

It bears repeating that everyone’s financial situation is different. Sitting down one-on-one with a financial planner is the best way to determine the optimal savings solution for you.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.

Planning for the Longest Vacation of Your Life- Retirement

Trying to calculate the amount that you need for retirement—your "number”— can be overwhelming and scary, especially in your 30s. Don't be afraid, be empowered. No one knows what company pensions or social security will look like by the time we retire, but we do know one thing—we cannot depend on anyone else financing our retirement. The sooner you set goals for retirement the better you will be able to adjust as life changes, and the more prepared you will be to live out your ideal retirement.

Not everyone has the same retirement need. Let's face it, your goal is to maintain your ideal lifestyle, not just to die before you run out of money. So the first step is to define your ideal retirement lifestyle. Once you figure out how much you need, then we can determine what it takes to get you there. According to the 2012 EBRI Retirement Confidence Survey, only 35% of workers age 25-34 and 41% of workers age 35-44 report having tried to calculate how much they need to save for retirement. Why bother calculating? The study also states “workers who have done a retirement needs calculation tend to be considerably more confident about their ability to save the amount needed for retirement.”

Meet Your Inputs

Before we begin the calculations, I’d like to introduce you to the variables used in the “time value of money” calculation, and the choices you make in each category:

Present Value- How much you have today. This is all of your assets earmarked for retirement. Ignore your home, your emergency fund, your checking account, and the savings you will soon spend on the vacation/ new home/ wedding of your dreams. This is not your net worth, rather the amount you have saved strictly for retirement today.

Choices: Which retirement accounts are available to you, including 401(k)s and IRAs? How much of your current assets are truly set aside for retirement?

Future Value- How much you will have in the future. There are two future values to consider: the amount of your retirement account at retirement, and the amount you would like left over when you pass away. I know what you are thinking- why do I care if there is anything left? It is important to consider whether you would like to leave funds to your kids, your favorite charity, or another loved one.

Choices: Is it important to me to leave a legacy or inheritance? How much?

Interest- The rate at which your retirement account will grow, and the rate at which inflation will grow. No matter what your financial advisor/ family member/ favorite TV pundit leads to you believe, no one knows the future market returns and inflation numbers. We do not live in a linear world and we will go through periods of high returns (and inflation) and periods of low or negative returns. Based on historical data for capital gains and dividends, I use 8% for accumulation (prior to retirement) and 6% for distribution (in retirement). The idea is that your investments are more aggressive before you retire and more conservative in retirement. I actually believe that these are conservative estimates for those of us in our 30s as the average 20-year stock market return, including dividends, is closer to 10%. I use a 3.5% inflation rate in my calculations. I'm sure you have all heard ad naseam the financial industry's disclaimer that "past performance is no guarantee of future performance." Apply it here.

Choices: How are your retirement accounts invested? Are you willing to take more risk for a potentially higher return? Can you afford to keep your savings in cash and low-return investments?

Period- How long you have to save for retirement, and how long your payouts will have to sustain you in retirement. In order to calculate both of these numbers, you must first make a retirement date assumption. Do you want to retire at 50? 60? 70? The normal retirement age for our age cohort, according to the Social Security Bureau, is 67. If you plan to retire earlier you will have to really ramp up your savings as you have a shorter period to save and those savings will have to last you a longer time. Remember also that you are penalized for retirement account withdrawals prior to age 59.5 (with some exceptions), so you will need a plan for income and healthcare prior to that age. When considering life expectancy, assume you will live into your mid- to late- 90s. This is where I would use the phrase "prepare for the worst and hope for the best," except that it infers that the "best" case scenario is dying early!

Choices: Ideally, when would you like to retire? What is your absolute date? Do you have a plan in case you are forced into early retirement?

Payments- How much is going IN your savings while you work, and how much comes OUT in retirement. This is very important, as this is the area in which you have the most control. In fact, your savings rate is single best indicator of you reaching your retirement goals. This is also the area where your ideal lifestyle comes into play, both pre- and post- retirement.

Choices: How much are you willing to forego today to save for tomorrow? How much will you need to withdraw in retirement? Does your company offer retirement plan contributions you can count towards your savings goal?  

What's My Retirement Income?

There are two primary methods of retirement income determination—the expense method, in which you calculate your actual expenses, and the income replacement ratio method, in which you simply assume a percentage of your current income. Both pose some problems. I believe it is virtually impossible to predict your expenses 30 years out from retirement. Look at the current retirees paying for internet and cell phones—who would have thought! And the issue I have with the income replacement method at this stage in our lives is that many workers in their 30s are still building their careers and growing their income. So while I prefer the income replacement ration, you will likely need to make some adjustments.

Planners typically use 70-80% of income as the replacement ratio. I have yet to see a retiree actually reduce their standard of living upon entering retirement. Who wants a lower standard of living once you actually have time to do what you want? And most retirees still have a hefty tax bill since the majority of retirement savings is tax-deferred. I prefer to determine retirement income using total current income minus retirement savings (won’t need that anymore!) and other expenses that legitimately end, like a mortgage.

So what if your income is still growing, and you would like to have more money to spend in retirement than you do now? I’m with you. My own retirement replacement ratio is 110%. It is absolutely ok to use a higher retirement replacement income in your calculation as long as you believe you will realistically make more than that amount at some point in your career. After all, we want to make sure you have money to enjoy prior to retirement!

Crunch Those Numbers

Now that you have determined your input values, you can let the calculators do the work of figuring how much your retirement account needs to be at retirement, and how much you need to save now to make it happen.

Three free internet calculators I recommend using:

https://isc.nwservicecenter.com/iApp/isc/rpt/launchRetirementTool.action (Nationwide) I like that the output screen allows you to play around with the numbers and see how changes to the variables affect the outcome.

https://www3.troweprice.com/ric/ricweb/public/ric.do (T Rowe Price) This calculator has won numerous awards, although I wish it took into account income growth.

http://www.dollartimes.com/calculators/retirement.htm - This one shows your account growth and then withdrawals year by year.

I list three because I am not completely satisfied with any of the free calculators I’ve come across. Try using all three to see where the differences lie. If your annual savings number is out of your reach, start with what you can afford and make a commitment to increase it by 5% or 10% each year. 

The most important thing to remember is that calculating your retirement goal should be an annual habit, not a one-time project. Your life will continue to change significantly prior to retirement, and as long as you are proactive with your retirement funds they will be there when you are ready to retire, regardless of life's surprises along the way.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.

When I'm 64

"Would you still need me, would you still feed me, when I'm 64?"- The Beatles

Ok, so the real title for this article is "Retirement Planning: A Five Part Series", something so boring only a personal finance nerd like me would ever even open it up. But I think it's important to first take a minute to recap WHY you need to even think about retirement planning. You are young and you are just now working your way into your dream career (or figuring out which career that even is). Why should you plan now for something so distant as retirement?

Which is why I refer back to the Beatles "When I'm 64". Paul McCartney was 24 when the Beatles recorded his satire of growing old with your love. Do you think he was anticipating that the day would ever come? Ask your parents, and they will be the first to tell you how quickly time flies (like you really want to open that can of worms). The life expectancy of a 30-year-old man is 77, and 81 for a 30-year-old woman. So chances are, you will see and pass the "normal" retirement age of 65. Will you still be working? Will it be your choice or will you be financially chained to your job? The goal of retirement planning is not to set it and count down to when you can watch re-runs of Jeopardy all day, it is to ensure you have the financial freedom to do what YOU want to do, when you are still able to do it.

I have a lot of friends who do not believe in retirement. Their attitude is, "I'll never have enough money to retire and will have to work my whole life anyway, so why save?". These people will save in their 401(k)s up to the company match, and then cash it out when they switch jobs. Or they don't plan to stop working because they enjoy it, or perhaps are business owners who reinvest every spare dollar back into their business. The problem with the "work-until-you-drop-dead" retirement plan is that your job may not be there for you anymore, or your business could fail and leave you with nothing. Harsh, I know, but the reality is that unemployed Americans over 55 have been the least likely to find another job during this recession, and the most likely to take a significant pay cut (15% versus 5% for those under 55). Many are forced into an early retirement. So even if you plan to continue to work, you may not have the option. A better strategy? Save money for retirement that you can deploy at normal retirement age, and choose to defer retirement if you are willing and able at that time.

An important reason for starting your retirement savings now (versus five years to retirement) is the power of compound interest. "Compound interest is the greatest invention of mankind" is a quote attributed to Einstein, and I have yet to meet a financial professional who disagrees. This would make negative compound interest the worst invention of mankind, but I will leave that to a future post on debt.

Compound interest is earning interest on the interest you've already accumulated. Imagine you invest $1,000 at a 6% annual rate, compounding monthly. At the end of month 1, you will have earned $5 ($1,000 x [6%/12]). At the end of the second month, you will earn another $5 from the principal, and in addition you will receive 2.5 cents of interest from the $5 of interest earned last month. Literally pennies, right? But it starts to add up. At the end of the year you will have earned $61.68 in interest as a result of the compounding, versus $60 if you only earned interest on the original investment of $1,000. The compounding continues, and at the end of 10 years you would have earned $819.40, or $219.40 more than the $600 earned from the principal alone.

Now apply the magic of compound interest to retirement savings. Let's say you actually listened to your parents/ mentor/ college finance professor and started saving $150 a month for retirement at age 22. By the normal retirement age of 65, you would have $363,377 in your retirement account (assuming a 6% return) and have only put away $77,400. Now imagine you did not actually listen to afore-mentioned advice-giver and don't start saving until age 42. You would have to put away $613.55 a month to match the $363,377 in retirement savings, a total contribution of $169,340. In other words, you save twice as much of your own money but end up with the same final amount.

Reality check- most likely you will not be able to retire with only $363k in your retirement account unless you have a government pension or a really flush trust fund. It takes a lot of money to retire. Once you make it to 65, a man has a 30% probability and a woman a 40% chance of living to 90. That is 25 years of supporting yourself on your retirement savings! Assuming the traditional retirement distribution rate of 4%, $363k provides you an income stream of $14,520 a year, which is below the poverty line for a household of two. The fact of the matter is that most of us will require at least $1,000,000 to sustain our standard of living through retirement. So start saving NOW, because the sooner you start the more you can take advantage of compound interest!

From a behavioral aspect as well, it is much easier to make a habit of saving now and then slowly increase the amount than it is to start saving a large amount all at once. Needless to say, I am not one who started saving right out of school, or even when I began working for a wealth management company that works directly with retirement savings. I was 26 before I opened a retirement savings account. I began by saving $50 each paycheck and rose it every time I got a raise or paid off some debt. Now I'm up to $375 a paycheck, which is a lot for me (a natural spender) but still not enough to get me to my goals. I understand that I will have to continue raising that amount to meet my retirement lifestyle needs.

Now that I have covered the WHY of saving for retirement, I will spend the next four posts enlightening you as to the HOW:

1. Determining Your Retirement Need
2. Company Retirement Vehicles
3. Individual Retirement Vehicles
4. Retirement Vehicles for Small Businesses and Self-Employed

Try to contain your excitement as you wait in anticipation!

Indentured Servitude (or Student Loan Debt)

Education is a good thing. I strongly believe that individuals should pursue educational opportunities at all times, and that a population of educated individuals is beneficial to society. So why am I negative on student loan debt? Haven't we already established that it is "good" debt, and an investment in your future?

The problem I have with student loan debt is that it is often entered into blindly. We are encouraged to go to college, and then often post-graduate programs, in order to increase our employment potential and obtain our dream job. If we have to take out loans in order to accomplish those goals, so be it. However, when a student takes out too much in student loan debt, he or she loses freedom and becomes bound by the obligation to pay the debt. It becomes more difficult to take time off work to travel, or visit with loved ones, or move into a career that pays a large personal dividend but a small salary.

I am not against student loans. I have a loan that I pay every month, and when I do it reminds me of the value of my well-rounded education and amazing college experience. Nor do I believe students should only take out loans for majors with "economic value." My Sociology major taught me how to research, write, and most importantly how to look at the world critically, a skill I use in business every day. I know a finance major who is now a veterinarian, an geology major now a Chief Investment Officer, and a philosophy major now a CEO. College should be about learning and exploring, and the more engaged you are in your classes the more you will get out of school.

That being said, education is expensive. And while the benefit side of the cost-benefit analysis is nebulous and not entirely monetary, there is a break-even point. One example is specialized master degree programs. I recently met a student preparing to apply to post-graduate programs in physical therapy. She expects a starting salary of approximately $70,000 a year and does not anticipate much salary growth throughout her career. She talked about the schools to which she is applying, and how the programs rank. Then she told me the cost. She would need a $250,000 student loan to attend her top school. She know it's a lot, but it is for her dream job helping people, and she would complete the program as a doctor of physical therapy. That's a worthy investment, right?

I immediately pulled out my phone and started crunching numbers (yes, I am a nerd and actually have a financial calculator on my phone). At today's rates, she would owe over $2,200 every month for 15 years! At $70,000, she would be paying more than HALF her take home salary every month in student loans, leaving her only $2,000 a month on which to live. She may love her job, but is she willing to take a vow of poverty for it?

I know many others who have found themselves in an indentured servitude situation. One earns $60,000 a year and pays $1,600 each month in student loans. Another is a lawyer with $200,000 in student loans who didn't pass the bar the first time, and took several months afterwards to find a job. Add an additional $30,000 in credit card debt to his loan.

At least those stories are people who enjoy their jobs and love their work. There are others who spend hundreds of thousands of dollars to learn that they do not want to be a lawyer, a doctor, or an investment banker.

Is paying that much for an education worth it? Sometimes it is. No one can value the worth of education and experience, but you can put a price to it. A great resource for estimating the cost of your loan is the calculator at FinAid.org. It will break down your monthly payments, and also calculate the future salary you need to earn to keep those payments to 10% of your gross income. In the physical therapist's case, it is  an annual salary of $266,305.20.

Most financial institutions will only loan you money if your debt-to-income ratio is less than 36%. Substantial student loan debt makes it difficult to qualify for a mortgage or even a car loan. And while the amounts I quoted may look like a typical mortgage amount, be forewarned that the interest rates differ significantly. Right now you can get a 15-year fixed mortgage for 3%, while a 15-year student loan will cost you more than twice that at 6.8%! I find it infuriating and unfair that student loan rates are this high at a time when interest rates are effectively zero. Another disadvantage to student loans over other loans is that student loans are extremely difficult to discharge through bankruptcy, especially within the first five years of payments. You can relieve the burden of a mortgage, medical debt, and credit card debt much easier than student loan debt. Like any other loan, make sure you are comfortable with your future payments before you enter into it, even if you lose your job or drop to a one-income family.

Now for the good news. Student loans can allow you to make a significant investment in yourself and put you on the path towards your dream career.  Your education is something that no one can ever take away from you, and learning how to think and learn is invaluable. Choose your education and its cost wisely, and no one will be able to indenture you.

Savings Vehicles

Congrats! Your budget is under control, you've paid off some debt, and you're now running a surplus. You are now ready to SAVE. So what do you do with that extra money in your bank account?

The first step is to get it out of your checking account. There are several reasons to set up different accounts for different purposes. The first is psychological; it is less likely you will dip into your retirement savings for a new pair of shoes if those funds are kept in separate accounts. The second is logical; some accounts offer more interest and potential for return but less liquidity.

Most people should have at least three accounts- a checking account for paying bills, a savings account for your emergency fund and short-term savings, and a retirement account that you do not plan to touch until you are at least 60 (typically a 401(k) or IRA). Some financial planners recommend that you open a separate account for each short-term and intermediate financial goal, however, that sounds like a lot of paperwork to me. I think it is absolutely fine to save for your wedding, home renovation, and upcoming vacation in the same account as your emergency fund and just track the overall amount you need for each goal. However, it goes back to the psychological- if you are more comfortable with four different accounts, or you want to be able to see how much you have saved for each goal right on your bank statement, then go for it.

Here is a run-down of common accounts that can be used for your savings goals:

Checking accounts
Savings accounts
Money market funds
CDs
IRAs
Company Retirement Plans

CHECKING- Interest rates are at historical lows right now (seriously, 4% mortgages?!). Good for loans, bad for savings. Especially bad for checking accounts, which often charge you fees and pay no interest. However, there are great deals out there. I recently switched from a large bank to a credit union, which has lower costs and actually pays me some interest to hold my money. Compare rates at http://www.bankrate.com/ or http://www.depositaccounts.com/, and make sure you understand all of the fees involved.

How much you keep in your checking account depends heavily on your spending habits, and how many people are accessing the account. If you are the only person on the account and you keep impeccable records, then you probably only need the amount to pay your bills and a buffer of a few hundred dollars. If you are like the rest of us and sometimes spend more than you plan in a pay period, or if both you and a spouse are drawing from the same account, then you should keep at least $500 in the account or keep it linked to another account in case of overdraft. Linking your account to a line of credit or savings account can prevent costly overdraft fees, but if you find yourself making a habit of accessing those funds then you need to reexamine your budget.

Remember that the purpose of a checking account is to keep money you plan to use in the very near future. Therefore, make sure you can access your funds easily and free of charge.  Look at ATM, electronic, and check writing fees, and make sure either the bank or the ATM is convenient to your regular schedule.

SAVINGS ACCOUNTS- Even with the best checking account, chances are that you can get better interest rates with a savings account. Less liquid, more interest. Look online at http://www.bankrate.com/ and http://www.depositaccounts.com/ to compare rates, and don't limit yourself to the bank that holds your checking account. Online savings accounts, including Ally, ING Direct, and American Express, offer competitive rates and make it easy to transfer money to and from your checking account.

Great for: Emergency Fund, Home Purchase and Renovations, Weddings, Travel, Cars, Short-term Goals

MONEY MARKETS- Money market accounts (MMA) and money market funds (MMF) typically offer slightly higher interest rates and more restrictions. Money market accounts are offered through banks, are FDIC-insured, have minimum balance requirements, and are limited to six withdrawals per month. Money market funds are mutual funds that are required to hold low-risk securities. They are not FDIC-insured. They usually require you to keep a minimum balance.

Great for: Emergency Fund, Home Purchase and Renovations, Weddings, Travel, Cars, Short-term Goals

CDs- Certificates of Deposit are offered by banks, FDIC-insured, and often offer higher interest rates. In return, you agree to leave your money in this savings tool for a certain time period, and you will be penalized if you take your money out early. The longer the CD term, the higher the interest rate typically. Some people choose to "ladder" CDs, in which case you buy longer-term CDs but space out your purchases every month/quarter/year. For instance, you may buy a 2-year CD every six months. This way you receive a higher interest rate than if you just bought a six month CD, but you still have a portion of your money available every six months. If you really like CDs and choose them as your investment vehicle, then I highly recommend laddering. Be careful to read the terms of a CD to make sure it has low fees and fits your needs. I personally do not like CDs over one year right now because interest rates are so low and you are locking yourself in at that low rate.

Great for: Home Purchase and Renovations, Weddings, Travel, Cars, Short-term Goals (as long as you time the maturity of the CD with when you will need the funds).

IRAs- Individual Retirement Accounts are personal accounts that you can start on your own to save for retirement, outside of a company retirement account. Traditional IRAs are available to anyone without a company retirement plan, or anyone who has a retirement plan but whose adjusted gross income (AGI) is less than $68,000 (if you file for taxes as single) or $112,000 (if you are married filing jointly). Roth IRAs are limited to those with an AGI  of less than $125,000 (single) or $183,000 (married filing jointly). The maximum IRA contribution is $5,000 per year (phased out as you get near the maximum income limits). This may not seem like a lot, but if you put away $5,000 from the time you are 30 until you turn 65, and earn 8% a year on your investments, you would have over $850,000 at 65!

IRAs can be confusing because they are an account, not an investment vehicle. You can invest in a number of different vehicles within your IRA account, for instance, you may have one IRA with mutual fund and stock investments, another in a CD, and another with only bonds. You can switch the investments within your IRA at any time and move it to a new IRA account (rollover), but you cannot take the money out of that IRA "bucket" and move it to your checking account without penalties.

Traditional IRAs are tax-deferred, which means you do not pay income tax on your contribution when you earn it, and you don't pay capital gains tax as you earn money off interest and investments. You will pay income tax when you withdraw the funds. Great incentives to save, but the government isn't just giving you these tax breaks for fun. These funds are earmarked for retirement, and you will be penalized 10% of any funds that you withdraw before age 59.5, in addition to paying income tax on the whole amount! That means that if you have a $10,000 IRA and you decide to pull it out to go to the World Cup, you will owe $1,000 in penalties AND owe income tax. If you are in a 25% bracket, you would pay $2,500 in taxes, which means that you only get $6,500 of your $10,000. So make sure that you leave the money in your retirement account for retirement!

Great for: Retirement Savings

Roth IRAs do not offer the immediate tax deduction of a traditional IRA, but allow for the funds to grow tax-free and be withdrawn tax-free. If you are in a low tax bracket or expect to be in a higher bracket in the future (either because of your earnings or higher tax rates), then this is a very powerful tool. You pay the income tax at your current rate and can withdraw it tax-free in the future when your tax rate is much higher. The other amazing feature of a Roth IRA is its flexibility- you can withdraw your contributions at any time without penalty! You are penalized for withdrawing the growth in your Roth IRA, but even then you are given some exclusions, including a first-time home purchase.

Great for: Retirement Savings, First time Home Purchase

COMPANY RETIREMENT PLANS- 401(k)s, Simple IRAs, and SEP IRAs are just a few of the retirement accounts that your company may offer. Companies will often match their employees' contributions, so make sure you are always contributing to the max! A dollar-for-dollar match is a 100% return in the first year, so don't ignore it. As with IRAs, you are penalized for withdrawing your company retirement funds before age 59.5, and you may need a certain amount of service with the company before you are allowed to keep all of the contributions they make on your behalf. When you leave a company, you are able to roll your "vested" funds (your contributions and growth plus the amounts you are entitled to from the company contributions and its growth) to an IRA or your new 401(k) plan. Company retirement plans can have high fees, but new regulations are forcing disclosure of all fees and encouraging companies to offer independent financial advice. This is a huge benefit!

Great for: Retirement Savings

We have just touched on the main points of a few types of accounts that can help you save for your financial goals. In the following months you will see more detail about these accounts, particularly retirement accounts. In the meantime, please comment and tell me how you separate your savings into different accounts.

Savings vs Paying Off Debt

We as Americans love to justify debt. Some arguments are more sound than others; for instance, it is easier to justify my student loan debt, which resulted from four years of excellent liberal arts education, than it is to claim that my frequent concert road trips warranted the many, many credit card charges. While I still proudly state that life experiences are priceless, it turns out that mine actually did cost money and I was responsible for paying it back. While trying to build an emergency fund, and save for a down payment, and pay off student loans, and invest for retirement. Sound familiar? So is it best to put the amount set aside for bettering your financial position towards paying off debt or increasing your savings?

 Many financial experts reduce the argument to simple math- if you are paying a higher interest percentage on your debt than you are receiving in your investments/savings, then use your cash flow to pay off debt. However, with today's tepid stock market performance and point-nothing returns on savings, a person following this "simple math" might be tempted to pay off his mortgage before saving a penny for retirement! This is not a healthy, sustainable plan, nor is the cookie-cutter "save for emergency fund > pay off debt > save for retirement". Everyone's plan will be slightly different based on goals, personality, and security requirements, however, there are some basic guidelines.

 Let's first distinguish between "good debt" and "bad debt." While the best debt is the one you've paid off, investment in an appreciating asset is typically considered "good debt"- a house, an education, or a business. "Bad debt" is acquired from anything that declines in value- car loans and credit cards (turns out the trips you've taken, the meals you've eaten, and the jeans you've worn are no longer worth the price you charged to American Express). The IRS actually recognizes the difference between the two, as they allow tax deductions for interest paid on home and student loans. Note that this is not a free pass to enter into a mortgage above your means or take out obscene amounts of student loans. Figure out how you'll afford the monthly payments in advance, and read the post "Indentured Servitude (or Student Loan Debt)" before taking on a big loan. Keep the total of ALL your monthly debt repayment amounts below 36% of your current monthly income (not the income you hope to make in 2 years).

DEBT- Start by listing all of your debts with the balance and interest rate. I personally do not worry about paying extra towards debt under 5% if it is a student loan or mortgage with tax-advantages. I also use 0% interest credit cards for large purchases (think fridge, computer, Home Depot supplies) and pay it over the time period to keep from putting a dent in my savings/ cash flow. I know that most personal finance bloggers are cringing right now, but come on. Free money for 6-12 months? One important caveat- if you cannot make all of the payments and pay it off during the 0% period, don't do it! You will get screwed in the end. Make sure you have the cash on hand to pay it off if necessary.

SAVINGS- Now make a list of your savings (even better, put your accounts in mint.com and have them show you the list). If you say "what savings?", there's a problem. Although I dispute the experts who say you should put six months of living expenses in a savings account before you touch your interest-accruing debt, I strongly encourage you to have at least the amount of one paycheck set aside in a savings account before you divert some of your cash flow to paying down high-interest debt. If your job is not secure, or you have a variable income, put aside a few month's worth of living expenses in the bank first. Base it off your own comfort level and employment situation. If you are saving for a down payment, wedding, or another big event you may need to pause your savings until your "bad" debt is paid off, but use your judgement. You don't have to put your home-owning dreams on hold just because you have a car loan.

RETIREMENT- I know that many people in their 30s do not believe in retirement. Maybe they don't think they will live that long, or perhaps they think that saving enough to actually retire on is impossible. Some think that they will save for it later, when they have more money to put away. Don't be one of them! The one point that all financial advisors agree upon is the power of compounding interest, and that the sooner you start saving the more you will have. Most working Americans save for retirement in either a 401(k) or an IRA, both of which offer tax incentives to save. If you have a 401(k) and your employer offers a match, always contribute up to the match, even if you have credit card debt. To not contribute up to the match is to turn down free money. The only exception is if you plan to leave your job within a year and will not meet your employer's vesting requirements. More about that in future posts.

 If your employer does not offer a match, I recommend that you still contribute a small amount to the 401(k). If you do not have a company plan, open an IRA and set up automatic deposits for each pay period. Do this even if you are paying off debt and can only contribute $20 at a time. You will create the habit of contributing to a retirement account, and it will be easier to increase your contributions as you pay off your debt. Also, the small but growing balance will (likely) encourage you to pay off debt so you can start stepping up your contributions.

PAYING IT OFF- Once you have established a small safety net, start tackling your "bad" debt. Pay the minimum on all of your debt except the one with the highest interest, and contribute all of your extra payment to that one card/loan. Once you pay that one off, apply those payments to the card with the next-highest rate, and continue until you have paid off all of your credit cards and lines of credit. This is called the "snowball method", because as you pay off one debt your payment to the next debt grows. Dave Ramsey coined this term and offers a free calculator on his site, as does mint.com. If you have higher interest student loans (I consider those to be over 6%), apply some extra payments to the principal, but you can also start directing some of your debt repayment money into savings.

After your "bad" debt is paid off, and you are making a dent in your high-interest student loans, you can go back to building a decent emergency fund. Again, the size of your fund will depend on your personal situation. I am currently a salaried employee with a stable job, so my goal is 4 months of "must have" living expenses. If you work on commission, or have a family to support, you may need up to 12 months of "must haves" for protection.

No "bad" debt, emergency fund in place, now it's time to up your retirement contributions. The goal is 12-15% of your gross income, and you can count employer contributions towards that total. As we discussed in "The B Word", your total savings goal is 20% of your income, so where does the other 5% go? The fun stuff! It may be a house, a wedding, or a fund to live off of while you start your own business, go back to school, or sail around the world. Maybe your idea of fun (or peace of mind) is not owing anyone money. In that case, put your "fun" savings towards extra principal payments on your mortgage or low-interest student loans.

Debt repayment and savings building can be a long road, so it's important not to get discouraged. Celebrate milestones- every card, or every large chunk. Acknowledge when you cut your debt in half, or double your savings. This is not a short-term goal, you are instilling a life-long habit. Put savings aside for your security and your goals, because you're worth it.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.