If you asked a search engine how to save for retirement, you might see a bunch of advice on working the perks in your 401(k). And that's great information -- unless you're one of many Americans who doesn't have a workplace retirement plan. In that case, learning about employer match or vesting schedules may help resolve your insomnia, but it won't help you reach your retirement goals.
Though the 401(k) might be a popular way save for retirement, it's not the only way. The first challenge you're likely to see when saving without a 401(k) is making savings contributions, month in and month out. The 401(k) automates this for you by pulling the money straight from your paycheck. Mimic that system by setting up auto transfers from your checking account, timed to fall on the day your paycheck is deposited. After that easy step, you're already on your way to retiring a millionaire.
As for where to put your monthly savings deposit, that depends on how old you are. Below are two strategies to build a seven-figure retirement account. The first and simplest approach is effective if you're in your 20s. But if you've already seen your 30th birthday come and go, take the second approach.
1. Max out your IRA contributions for 40 years
If you are in your early 20s, congratulations are in order, because you have options. With 40-some years ahead of you to save, you don't need a 401(k) to reach your seven-figure savings goal. A traditional or Roth IRA can do the job on its own.
A compound earnings calculator will tell you that you can reach $1 million by saving $400 monthly for the next 40 years. That assumes you have those savings invested to earn 7% after inflation and taxes. That's reasonable, considering 7% is roughly the average, long-term growth rate of the stock market after inflation. You don't have to worry about year-to-year taxes, because the earnings in your IRA are tax-deferred.
Sounds easy, right? It is, but there are some pitfalls that can derail this millionaire plan. The first one is investing in the wrong securities. If you're new to investing, the simplest path is to lean on index funds, such as the Vanguard 500 ETF (NYSEMKT:VOO). This fund gives you a slice of 500 of the largest publicly traded companies in the U.S. You'll see near market-level returns without too much work on your part. In the meantime, look to broaden your investing knowledge so you can expand your portfolio later.
A second pitfall is moving in and out of the market because you're worried about volatility. That strategy often results in lower overall returns, even as you're trying to prevent unnecessary losses. This happens because you often end up missing the market's best days instead of the worst ones. According to a 2020 J.P. Morgan report, the market grew about 6% annually between January 2000 and December 2019. But if you had missed the market's 10 best days during that time period, your average returns would have dropped to less than 2.5%.
The takeaway here is to stay in the market, even when it seems like everyone else is selling. You'll be better for it.
2. Contribute to IRA and a taxable account
If you are older than 25 or 30, your millionaire retirement plan will require an extra step. Here's why. The amount you can contribute to an IRA each year is limited. In 2021, for example, you can deposit up to $6,000 total across all your IRA accounts until you turn 50. If you're 50 or older, you can contribute up to $7,000. That equates to $500 monthly or $583 monthly after 50. And even if you have a full 30 years to save, a $500 monthly contribution won't get you to $1 million.
That means you'll have to max out your IRA contribution each year and additionally save to another account. Your second account can be a taxable brokerage account. You will pay taxes on the realized gains, dividends, and interest earned in that account each year, but you won't have any withdrawal restrictions. You can keep your tax bill low by investing in tax-efficient mutual funds and non-dividend-paying stocks you can hold for long periods of time.
The total amount you'll need to save monthly depends on how many years you have between now and retirement. You can use the SEC's savings goal calculator to run the numbers. Use 6% or 7% as your estimated interest rate, which assumes you'll be invested in the stock market. The calculator will return your monthly savings target. Plan on investing the first $500 in your IRA and any amount over $500 in your brokerage account.
Don't wait for a 401(k)
When it comes to retirement saving, it's critical to get started early -- and that's especially true if you don't have a 401(k). Waiting even a few years can dramatically increase the amount you need to save each month to reach your goals. Wait 10 or 20 years and you may see your retirement wealth goals slip out of reach. Also know that even if you can't save as much as you'd like, saving something is better than saving nothing.
So get to it. Today's the day you put your millionaire retirement plan into action.