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6 Keys to Nail Your Retirement Plan

By: Matt | The RN Mentor

There are 6 keys to nail your retirement plan, and hopefully, you learn them at a young age. Investing wisely for retirement is one of the most important financial actions we can make. However, most people don’t take retirement planning seriously enough, early enough.

Many Americans find it challenging to save at all, never mind saving for decades down the road. Yet the difference between saving aggressively while young, or waiting another decade, can cut your retirement savings by upwards of 50%.

After you use your BLS skills to resuscitate your finances, you should have ample room to start saving for retirement.

To nail your retirement plan at work you must understand the following concepts:

  1. The 4% Rule
  2. The Wealth Snowball
  3. Understanding Fees
  4. The Amount to Contribute
  5. Target Retirement Accounts Vs. Build Your Own
  6. Roth vs. Traditional Accounts

Disclaimer: I am not a financial professional and do not pretend to. You are responsible for your own investment decisions and my choices are due to my particular investment philosophies and values. I am only a nurse with a passion for financial decision-making. In other words, please don’t sue me for your financial decisions. I have no affiliation with Fidelity, but use their website often to supplement with great images that depict these concepts without concern for copyright infringement.

Understanding Retirement

1. The 4% Rule

Financially speaking, the ability to retire boils down to the ability to cover living expenses over decades. Most financial institutions erroneously state that you should aim to replace 100% or more of your income. This would assume a lavish lifestyle and that your spending will increase over time, instead of a decrease. They fail to consider that most retirees will no longer have a mortgage, nor will they need to continue saving for retirement.

You can roughly calculate your retirement goal by a calculation known as the 4% Rule. This is the first key to nail your retirement plan because it answers the question, “how much is enough?”

The rule states that when you are able to live off of 4% of your retirement account, you can effectively retire. In other words, you can retire once you save 25 times your living expenses. Therefore your ability to retire is then a byproduct of both your expected living expenses and the amount you’ve accumulated. To reach an “early retirement” you can either increase your savings rate, cut your living expenses, or both.

The premise of the 4% rule is that on average, the stock market returns an average of 7% return. If your retirement portfolio is 100% in the stock market, then a 7% return minus a general 3% inflation rate will allow you to live off from it in perpetuity, without a significant decrease in total accumulation.

There are many nuances to the 4% Rule, and there is an incredible amount of information written about it. Some try to shoot holes through it, while others dedicate their entire livelihood to defending it. For the purposes of this blog, I’ll leave the detailed reports to those who already eloquently wrote about it. It’s a rabbit hole that is beyond this post.

2. The Wealth Snowball

giant snowball
By Kamyar Adl (Flickr)

Albert Einstein once wrote,

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

The wealth snowball is a metaphor coined by J.D. Roth at Get Rich Slowly. When invested properly, the earlier you save, the less you eventually have to save. As snowballs increase in size, they pick up more and more snow with each revolution. Similarly, your investments will earn more and more of its own money each year, simply by reinvesting dividends into more shares.

The Rule of 72

The Rule of 72 is another mathematical formula that informs us how long it takes for money to double. This post uses the historical stock market return of 7% when calculating investments. Effectively:

72 / 7 = 8 years.

With a 7% return on investment, it takes 8 years to double your money.

This takes us back to the wealth snowball metaphor. By starting young, say at age 21, your money will receive an extra doubling period than someone starting at age 29. Now, if the 21-year-old saves aggressively, the amount available to double within that time frame can create incredible wealth compared to the 29-year-old. This earning difference translates into either an earlier or a more luxurious retirement.

Understanding the concept of the wealth snowball makes it easier to understand why the 4% works. If we only add to our retirement account, it continues to generate more and more of its own money and turns into its own money-making machine. Eventually, the decision to retire early (and safely) comes when we can start living off the snowball’s accumulation. Fidelity has a great image that depicts this effect.

3. Amount to Contribute

Unfortunately, there is no correct answer. However, with knowledge of the Rule of 72, you know the earlier the better, and the more the better. Fidelity provides a simple article that provides goals by certain age milestones.

  • By 30 years: Save 1x salary
  • 35 years: 2x salary
  • 40 years: 3x salary
  • 45: 4x salary
  • 50: 6x salary
  • 55: 7x salary
  • 60: 8x salary
  • 67: 10x salary

Most work retirement plans allow you to opt into a program that automatically increases retirement contributions each year up to 10%. This strategy helps those who struggle with parting with their money. A 1% annual decrease in a paycheck is fairly negligible and it’s a way to eventually reach a reasonable retirement contribution.

Fidelity suggests that you save at least 15% from age 25 through 67. I can’t recommend an exact number, as it’s based on your personal values and is truly a practice of deferred gratification. The maximum contribution is $18,500 for an individual each year unless you’re older than 50, and you are granted an extra $6,000 contribution to “catch up”.

4. Understanding Fees

You must consider fees when choosing investments. Frequently reported as an expense ratio, these percentages can seem minuscule, but have dramatic effects on investment returns over time. The Securities and Trade Commission even warn of investment fees on their own website.

Nerdwallet provides a realistic scenario that we could all face in our hospital retirement investment options. They sought to find what would happen if a 25-year-old started with $25,000 in a retirement account and then contributed $10,000 every year for 40 years. They used a 7% average annual return (same as my previous example).

  • In Scenario A, the employee’s investments have a 1% expense ratio.
  • In Scenario B, the employee’s investments have a 0.07% expense ratio.

In the second scenario, the employee saves almost $215,000 in fees. If that amount of money remained in their own account, it would result in retiring with $533,000 more in their account.

Do I have your attention now?

There are plenty of articles that show this caustic effect of fees on retirement accounts. I like this article because 1% isn’t even an outrageous number to find for a fee. Most wealth management companies will charge this, and it doesn’t appear to be a large amount. On the other hand, a 0.07% expense ratio is easily achieved (and beaten) through a Vanguard investment option.

5. Target Retirement Funds vs. Build Your Own

If you’re looking for “Easy Button” for retirement savings, then opt for a target retirement fund. In the target retirement fund or age-based portfolio, employees select a fund based on the year they expect to retire. Investments are allocated heavily into the stock market (higher volatility but much more growth potential) when the retirement is far into the future. The closer that date comes, the more weight is shifted into bond funds – thus providing more stability as you near retirement.

More savvy investors can select funds to create their own portfolio. You may choose this route if you feel they can earn better returns than a target retirement fund, if you want more or less aggressive investments, or if you want a lower expense ratio.

If you’re new to investing, please do yourself a favor and just hit the “Easy Button” (this is often the default choice if you do not choose a fund anyway). The fund options will quickly discourage someone who isn’t familiar with investing.

For a decade I invested in a target retirement fund and only recently built my portfolio. I did this for two reasons. I recognized that the expense ratio of my target retirement fund was 0.63% and I could cut it to 0.04% by selecting a Vanguard total stock market index fund.

This means that I’m paying 15x fewer expenses than before. That’s more money I keep and more money creating my wealth snowball. I realize that I will eventually have to make my investment more conservative, but after reading the section on fees above, you know why.

The second reason for building my portfolio was due to my continued research into reaching financial independence. I’ve studied investing for nearly ten years, but recently stumbled upon a financial blogger who built upon my philosophy of investing in index funds. His stock market series is an incredibly useful tool to better understand investing.

6. Traditional vs Roth 401k/403b

Most nurses can participate in their employer’s 401k (for-profit organizations) or 403b (non-profit organizations). In essence, they are the same, it’s the nature of the company that determines which you have access to.

The 401k or 403b has a max contribution of $18,500 each year. In addition, your company may offer a “match” up to a certain contribution. Those company contributions are in addition to the max personal contribution limits.

Contributions to a Traditional 401k or 403b are pre-tax and are deducted from our taxable income. We pay no taxes on the current income, but instead, pay the taxes when distributions are made in retirement. In retirement, our retirement savings, both contributions, and their investment earnings, are essentially treated as income.

Roth 401k/403b contributions are post-tax. You pay taxes at your current tax rate, but in retirement, the earnings and the contributions aren’t taxed again.

If you work in an organization that provides both traditional and Roth retirement plans, the decision comes down to two factors

  1. Your current tax bracket
  2. If you feel your retirement tax bracket will be lower than it is today

Most people feel their tax bracket in retirement will be lower than now. Others fear that tax rates are likely to rise in the future, and as long as the government keeps to their word, they should pay the tax now and be done with it.

My wife and I max our contributions to the traditional 403b. Two years ago our combined gross income put us partially into the 28% tax bracket. Switching from Roth to traditional 403b shelters $36,000 from our taxable income.

Summary

In summary, the six keys to nailing your retirement plan are:

  1. The 4% Rule
  2. The Wealth Snowball
  3. Understanding Fees
  4. The Amount to Contribute
  5. Target Retirement Accounts Vs. Build Your Own
  6. Roth vs. Traditional Accounts

The main points to understand are:

  • You can effectively retire when you save 25x your annual living expenses
  • Save as much as you can, as early as you can, to give your wealth snowball time to accumulate
    • If you still have student loans, these take initial priority if over 5%
  • ALWAYS know the expense ratio of your investment funds
  • Target age retirement plans are the “Easy Button” for investment decisions, I don’t recommend creating your own investment portfolio unless you are extremely comfortable doing so.
  • Deciding to invest in a Roth or Traditional retirement account depends on your tax rates

As stated in my about me page, I follow the advice and rationale of the Financial Independence and Early Retirement (FIRE) movement. To learn more about how to retire early, I suggest starting with The Shockingly Simple Math Behind Early Retirement. For me, writing on early retirement will have to wait for another day.

Republished with the permission of TheRNMentor.com.

3 replies on “6 Keys to Nail Your Retirement Plan”

Steve, you might have a typo in this post.
You state that “With a 7% return on investment, it takes 8 years to double your money.”.

It should be with a 9% return on investment, since 72/9 = 8.
For 7% it would be 10.2 years.

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