It's totally possible for ordinary nine-to-five workers to retire multimillionaires -- and you just might have to if you want to have enough savings to last you several decades. It's not always an easy thing to accomplish, but there are a few things you can do to set yourself on the right path. Here are three strategies to keep in mind if you'd like to retire with $2 million or more.
1. Save as much as you can for retirement annually
Obviously, the more you can stash away each year for retirement, the easier time you'll have hitting your multi-million-dollar savings goal. This is especially true for those who begin saving while they're young, because these early contributions have the most time to increase in value before you need to use them.
Consider a $1,000 contribution made when you're 25. If you earned a 7% average annual rate of return, that $1,000 would be worth nearly $15,000 by the time you were 65. But if you waited until you were 30 to put that $1,000 into your retirement account, it would only be worth around $10,700 by the time you hit 65. That extra five years of growth adds up to about $4,300 more. And the more you contribute, the more time can work in your favor.
If you can afford it, the fastest way to achieve retirement multimillionaire status is to max out your retirement accounts annually. In 2020 and 2021, that means contributing $19,500 to your 401(k), or $26,000 if you're 50 or older. You can also contribute up to $6,000 to an IRA, or $7,000 if you're 50 or older. But don't exceed these limits, or else you could run into tax penalties that set you back.
2. Choose the right retirement accounts
As mentioned above, some retirement accounts enable you to contribute more than others, but that's not the only distinction to keep in mind when deciding where to stash your savings. One reason 401(k)s are so popular is that many employers match a portion of their employees' contributions, which can help workers grow their savings more quickly. But 401(k)s usually have limited investment choices compared to IRAs, so if you don't like your options, you may be better off saving in an IRA first and returning to your 401(k) only after you've hit the IRA contribution limit.
You also have to weigh when you want to pay taxes on your savings. Tax-deferred accounts, like most 401(k)s and traditional IRAs, are the smarter choice if you think you're in a higher tax bracket today than you'll be in once you retire. Delaying taxes until you're in a lower bracket will help you hold onto more of your savings. But that also means that not all the money in these retirement accounts belongs to you. So if you're saving exclusively in tax-deferred accounts and you think you'll need $2 million to afford your retirement, you may actually have to save even more, so you have enough to give the government its share.
Roth retirement accounts give you tax-free withdrawals after you pay taxes on your contributions. One of these is your best option if you think you're earning about the same or a little less than what you'll spend annually in retirement. Paying taxes now on just your contributions will be more affordable than paying taxes on your contributions and earnings later. Plus, all the money in these accounts is yours to keep, as long as you have the account for at least five years before you withdraw your funds and don't withdraw any earnings before age 59 1/2.
3. Don't be too conservative with your investments
In financially uncertain times like these, safer, more stable investments like bonds look more appealing than volatile, but potentially more lucrative, stocks. It's a smart idea to have some of your money in stocks and some in bonds at every age, but the ratio should change over time.
When you're younger, you should keep more of your money in stocks to take advantage of their growth potential. You may lose money in the short term, but since you have decades to recoup these funds before you need to spend them, the loss isn't as big of a deal. As you age, preserving what you have becomes more important than gambling big on stocks, so you should move more of your money into bonds.
The risks of being too aggressive are obvious, but being too conservative can be problematic as well because your savings will grow more slowly. That will force you to set aside more money every month to reach your goal, and if you cannot afford to do so, you may not get there at all. It's better to maintain an appropriate balance of stocks and bonds for your age and risk tolerance.
The traditional rule was that the percentage of your portfolio you should invest in stocks was 100 minus your age. So if you're 60, you should keep 40% of your money in stocks. But with people living longer these days, 110 or 120 minus your age is more appropriate. In addition to diversification, this will help keep your savings protected without costing you a lot of potential investment earnings.
These rules are useful to keep in mind even if you're not trying to save $2 million or more for retirement. But it isn't a bad thing to aim for this number, even if you don't think you'll need that much. Living expenses are only going to rise over time, and you can never predict all the costs that'll come up in retirement. It's always better to save too much than not enough. If you don't use it all, you can pass the extra along to your heirs.