The best time to start saving for retirement is now. However old you are, waiting is unnecessary. Even if you’re in-between jobs, putting a few dollars aside keeps the habit going and all adds to that 8th wonder of the world: compounding interest.
However, getting started is difficult. Talk of allowances, annuities, inflation, maxing out 401Ks and diversifying your portfolio is a certified way of putting you off even beginning. The issue is that whilst these are things you want to become familiar with in order to prevent mistakes and optimize your retirement plan, they are not prerequisites to starting. That is the misconception, that only the sort of people that already know this stuff are those who can invest from a young age.
The jargon is certainly a barrier, but it can be overcome. Here are some of the most basic concepts you should know and some ways to invest as, say, a broke student.
Easy, functional options for retirement saving
Automation is key
First thing’s first, pensions are at the core of retirement savings. Pensions offer the ability to have annual income until death, no matter how long you live, once you reach the agreed age of retirement. They can also be great ways to pay less tax and can be taken out early in a lump sum.
So, paying into a retirement plan is a clear necessity. If you’re employed, you can pay into a 401k (a pension pot, essentially) directly out of your pay. This means there’s no chance of spending the money first. Automated retirement contributions such as this are at the core of lazy retirement planning – nothing can go wrong and you can forget all about it. It removes the temptation – the choice – to spend it elsewhere.
Being self-employed or a non-working student makes this a little more difficult. However, you can still set up direct debits/standing orders into a 401k yourself and let money drip out of your account each month.
Another great tool is Robo-advisors. These are essentially companies (websites) that let you contribute monthly (or just a one-off) and they invest for you. They claim to be AI investors with an intelligent bespoke algorithm. They’re not. They’re nothing special. They invest in a mixture of bonds and index trackers that follow a few markets and they take around 0.5% as a cut.
But reading up about Vanguard, making an account and doing the same with a few others doesn’t sound appealing. Robo-advisors are actually a great resource to get you started. You can let them take out fixed, monthly contributions from your account and you may end up getting a 6% return if the western economy does reasonably well that year.
Annual returns can vary widely, from potentially losing money to getting over 10%, but considering they’re longer-term than one-year investments, they’re a safe bet with decent returns. Very few can beat the market, let alone when getting started so investing in the market itself (or a tracker that mirrors the market) is a great place to start.
No matter how keen you are to start saving for retirement, you must keep some of your assets liquid. This means not tying up your savings in bonds that you can’t sell quickly, or savings accounts that you can’t access for 5 years.
Yes, these usually offer better returns. But always keep a month or two worth of expenses as either cash or easily accessed deposits. This is vital to giving you a safety net throughout your journey to retirement.
The importance of whether your investments return 4% per year or 6% per year pales in comparison to being able to save more. Learning how to save on a small scale in everyday situations is what will lead to long-term results. For example, cycling to college instead of driving, learning to cook, not buying coffee at lunchtime.
Increasing your savings rate (% you save in relation to income) from 5% to 25% isn’t all that hard, but it could be the difference between saving $100 per month and $500. That’s around $100k more in savings over 20 years – but it would be more than that of course because you will have gained more from compounding interest too!
Frugality can become a subconscious mindset that will prepare you for retirement, where you won’t have enough money to be splashing out on eating out every day and such (compared to your working pre-children life).
Understanding tax relief
The government understands the necessity of having money at an old age, and how difficult this is when you cannot work. However, they also understand how expensive paying pensions are. To promote our efforts and focus on private pensions, there are tax advantages to saving for many of them.
The specific reliefs will depend on which country you’re in, but generally, there is tax relief on private pensions and many ISA savings accounts. This means you can reduce your taxable earnings in the now, by saving for the future.
When the future comes around and you want to receive your pension, there will likely be tax relief wherever you are. In the UK, 25% of your pension will be tax-free. It doesn’t matter whether you take it out in a lump sum or as annuity payments, the first 25% will be tax-free. Of course, if you’re properly retired and have not just taken your pension early, it’s unlikely that you will be earning enough to pay tax anyway, as there is a personal allowance of £12,500 (in the UK). This means you may end up never paying a penny tax on your pension. Compare this to the tax you would have paid if you didn’t save it throughout your life – you will have likely saved tens of thousands in tax. Saving for retirement is a marathon and reducing tax is just as important as making more returns on investments.