Your 40s are an interesting time of life from a financial perspective. On the one hand, you're probably past the point of paying off your student loans, and you're not yet dealing with the astounding cost of college tuition. On the other hand, 40-somethings still have a host of expenses to deal with, from mortgage payments to summer camp to everyday costs that magically manage to increase over time.
If you're in your 40s, you may be so focused on your immediate expenses that you've yet to put much thought into retirement. After all, it's still a good 20 years away -- or more. But your 40s are actually the perfect time to get a handle on retirement, and with that in mind, here are a few moves to focus on.
1. Ramp up your savings
Chances are, you're earning more in your 40s than you did in your 30s -- in which case it pays to stick as much of that money as possible into a retirement account. The beauty of IRAs and 401(k)s is that they offer tax-deferred growth on your investments, which means that instead of paying taxes on your gains year after year, you can reinvest them and grow your nest egg significantly.
Not only that, but funding a traditional IRA or 401(k) will give you an immediate tax break, which will probably come in handy if your salary has increased. A $5,000 contribution to either account, for example, will shave $1,250 off your tax bill if your effective tax rate is 25%.
But crucial as those tax benefits are, the real reason to save aggressively for retirement in your 40s is that you still have time to take advantage of compounding. Say you're able to save $5,000 a year starting at age 45, with the goal of retiring at 65. If your investments generate an average annual 8% return (which is just below the stock market's historical average), you'll be sitting on an extra $229,000 by the time you're ready to leave the workforce.
On the other hand, if you wait until age 55 to start saving that same $5,000 a year, you'll have just $72,000 for retirement, which is only a third of what you would've accumulated by starting in your mid-40s. The more time you give your money to grow, the more you'll benefit from compounding and tax-deferred earnings, so now's the time to focus on increasing your contributions.
2. Reduce your debt
It's one thing to carry mortgage debt in your 40s, but credit card debt is a different story. Yet a large number of 40-somethings are drowning in credit card debt. In fact, consumers in their mid-40s to mid-50s have the highest levels of credit card debt than any other age group. Not only that, but the typical borrower in that range is lugging around a balance of over $9,000. Ouch.
If you're carrying a hefty credit card balance, it's time to start chipping away at that debt as soon as possible, with the goal of eliminating it completely by the time you reach your 50s. Why the deadline? First of all, the sooner you knock out that debt, the less interest you'll pay. Furthermore, by the time you reach your 50s, you're likely to face one new major expense -- college. Freeing up cash by the time your kids' tuition bills come due can help you and your children avoid loads of student debt.
Another good reason to pay off credit card debt in your 40s is that by the time your 50s roll around, you should really be focusing on eliminating another source of debt -- your mortgage. The less debt you carry into retirement, the less financially stressed you'll be once you start living off a fixed income, so it pays to tackle your debt step-by-step, starting with credit card debt in your 40s.
3. Review your investment fees
A frightening number of adults who do save for retirement with an IRA or 401(k) have no idea how much money they're losing to fees. If you've been neglecting your retirement plan, now's the time to review your investments and make sure you're not giving up more money than necessary.
As a general rule, you'll typically pay more for actively managed mutual funds than you will for index funds. That's because index funds are passively managed; they simply seek to match the performance of existing indexes, such as the S&P 500.
Not only do index funds have lower expense ratios, but they tend to deliver better returns than their actively managed counterparts. In fact, a recent Morningstar study found that between 2004 and 2014, index funds performed better than actively managed funds on a whole. Before you spend the next 20 years throwing money away on fees, take the time to explore some lower-cost options for your portfolio.
With retirement just two decades away, your 40s are the perfect time to boost your savings, get out of debt, and eliminate fees that could eat away at your long-term returns. While it may be too soon to start counting down to retirement, focusing on it now can set the stage for a financially secure future.