Once upon a time in America, retirees had a "three-legged stool" to support them: Social Security, their savings, and employer-provided defined-benefit pension plans that provided guaranteed streams of income.
Today, just over 10% of workers have a defined benefit pension plan, down from around half of all private sector workers in the 1980s. That means for millions of seniors, the other two legs of the stool have to be strong enough to carry all the weight.
With Americans on average living longer than ever, it's important to do all you can to build a stable foundation for retirement. These four proven methods to boost your retirement income could go a long way to help.
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1. Maximize Social Security benefits
For 71% of single retirees and 50% of married ones, Social Security provides at least half of the household's retirement income. If you'll be among those relying that heavily on Social Security, you'll want to get the most out of it that you can.
- Work at least 35 years. The Social Security Administration calculates your benefits using a formula based on your highest 35 years of wages, adjusted to account for wage growth. If you've worked less than 35 years, you'll have some $0s averaged in, which drags your result down significantly. Compare two people who've earned the equivalent of $50,000 throughout their careers, one of whom worked 35-years and the other who worked 30 years. Social security benefits would be based off a $50,000 average salary for the first, but a $42,857 average salary for the second.
- Understand FRA. FRA stands for full retirement age. If you were born in 1960 or after, your FRA is 67. If you retire earlier than your FRA, benefits are reduced by 5/9 of 1% per month for the first 36-months and an additional 5/12 of 1% for each month thereafter. If you retire after FRA, benefits increase by 2/3 of 1% per month of delayed benefits until aged 70. The average monthly Social Security payout of $1,369 would be reduced to $958 for someone who retired at 62, or raised to $1,697 if they retired at 70.
- Coordinate with your spouse. Married couples and divorcees who were married to each other for at least 10 years can claim benefits based on their spouse's work record. There are 81 different claiming strategies for married couples. So research your options: you may be able to significantly increase the size of your checks.
Earning more money also increases your Social Security benefits. To maximize your income, negotiate your salary when you're hired, and consider a side hustle to boost earnings.
2. Invest more money
Even if you're smart about your strategies around claiming government retirement benefits, it's still difficult to live on Social Security alone. The average payment puts you near the poverty level, and even the maximum benefit taken at age 70 gives you only about $44,000 in annual income.
Clearly, you'll need some investments to help pay the bills, so you'll want to invest as much as you can. To make that possible:
- Cut unnecessary spending: To reduce expenditures without big lifestyle changes, avoid waste, like buying food you don't eat or paying for unnecessary subscriptions. Track your spending and live on a budget that prioritizes savings.
- Make slow-and-steady increases: You should be saving around 15% to 20% of your income for retirement, but you'll likely have to work your way up to those levels. Any time you get a raise, divert it to retirement savings before getting used to living on it. And, try to increase your retirement account contributions by small amounts over time. An annual increase of $1,000 starting at age 30 -- less than $40 per paycheck if you're paid biweekly -- could turn into more than $160,000 in extra savings by the time you retire.
- Automate your investments: Setting up automatic contributions to retirement accounts makes you less likely to skip them.
Thanks to the enormous power of compound growth, the earlier you start, the bigger your edge. If you started investing at 20 and saved around $300 monthly throughout your career, the odds are excellent that you'd retire a millionaire. If you waited until 40, you'd need to invest more than $1,400 per month to have the same size portfolio when you were done.
3. Take full advantage of tax breaks
Uncle Sam wants to encourage us to save more for our golden years, and he's offering some portfolio-boosting incentives to do it. But it's up to you to take advantage by making maximum use of those tax breaks for retirement savings.
There are a number of tax-advantaged retirement savings accounts, including:
- 401(k)s: You can invest up to $18,500 in a 401(k) in 2018 if your employer offers one, or if you're eligible for a Solo 401(k). Investing in your 401(k) is simple since your employer opens and maintains the account. However, investment options can be limited. Invest at least enough to earn any employer match, then consider available investments to decide whether to invest more in your 401(k) or switch to another account.
- IRAs: In a traditional IRA, you invest with pre-tax funds, while a Roth IRA requires investing with after-tax dollars -- but your withdrawals in retirement are tax free. There are income limits if you or your spouse is covered by a workplace retirement plan. There are also additional IRA options for the self-employed with higher contribution limits.
- Health savings accounts: If you have a high-deductible health insurance plan, you can invest in a health savings account with pre-tax dollars. HSAs can be invested in a wide range of different investment products. Plus, you can withdraw the money tax-free to pay for medical costs. Since seniors may need up to $350,000 for healthcare, having a separate, tax-advantaged account to draw on when it's time to cover these expenses can be a big help.
Tax breaks can have a major impact on your retirement investments over the long term. If you invest $5,000 annually in a taxable account over 30 years, and pay 25% federal taxes and 6% state taxes, you'd end up with almost $378,000, assuming a 7% rate of return. But, if you invest the same amount in a tax-deferred account, you'd have a nest egg of more than $472,000. The tax break makes almost a $100,000 difference.
4. Invest the right way
When you've worked hard to set aside money to invest, the last thing you want is for your investments to underperform. You can maximize the chances your investments will do well by:
- Keeping investment fees to a minimum: Paying too much in fees could cost you hundreds of thousands of dollars over the years. If you invested $5,000 annually at 7% from 30 to 65, you'd end up with about $620,000 if you paid 0.5% in annual fees -- but just $501,000 if you paid 1.5%.
- Taking the right level of risk: To earn reasonable returns, you need to take reasonable risks. If you started investing at 30 and achieved an average annual 8% return -- very possible if your money is in stocks -- you'd need to invest just $5,373 annually to retire a millionaire at 65. But, if you chose only conservative investments like bonds, and earned just 2%, you'd need to invest $19,610 a year to achieve the same result -- and setting aside that much isn't feasible for most of us. To determine what percentage of your portfolio to put in stocks, a good rule of thumb is to subtract your age from 110. So, for example, if you're 30, stocks should make up 80% of your portfolio.
- Understanding your investments: While you want to take risks, they need to be calculated ones-- which means you should never invest in anything you don't understand. If you're not sure how to evaluate individual companies, opt for mutual funds or ETFs to get your money into the market.
Once you've got your money invested, leave it alone to work for you. Don't take a 401(k) loan, and don't let emotions rule your investment choices.
Building the foundation for a secure retirement
While one of the traditional legs may be missing from your retirement stool, you can still build a secure financial foundation by following these tips. Get started today so you won't have to worry about being a low-income retiree.
