Retirement planning involves a lot of variables and requires a steadfast commitment to creating a corpus that can cover life’s unforeseen events and sustain your pre-retirement lifestyle for decades into retirement. The motivation to diligently contribute towards retirement investments is directly linked to an individual’s savings capability, which has stunted in recent years due to record-high living and borrowing costs, muted wage growth, ill-informed investments in volatile markets, and easier-than-ever access to short-term credit. While accumulating generational wealth alone is arduous, holding onto your hard-earned money and protecting it from market risks, taxes, and inflation is a totally different ball game. Millionaire author and the host of Netflix’s “How To Get Rich” shared his 7-step retirement playbook in a recent YouTube video to help you retire much richer than you imagined.
Step 1: Set Your Retirement Number
How much do you need in retirement? How much money do you want to retire with? These are the most common questions in a person’s mind when planning for retirement. While figuring out how much you want for retirement can take time, it can also lead to anxiety for many about the unknown. Thinking about how much you need in the next 10, 20, or 40 years, especially when you have yet to start saving for the future, can likely lead to stress. Many Americans think having $1.4 million is enough for retirement, which goes up to $1.6 million for GenZ and millennials. While these numbers vary for each person, applying financial adviser Bill Bengen’s 4% rule can help answer how much you need to cover costs through retirement and make your wealth last as long as you do. The rule states that you can safely withdraw 4% of your retirement corpus annually in the first year, followed by withdrawing the same amount adjusted for inflation in the following years. For instance, you can withdraw $40,000 on a $1 million corpus in the first year. If inflation rises by 2% in the second year, you adjust the prior year’s withdrawal amount accordingly to $40,800. Bengen found that this method allows one to retain the purchasing power of the 4% drawn in the first year of retirement, which can help savings last for three to five decades.
The best way to apply this rule is to determine your annual spending and divide it by 4% or 0.04 to find how much you need to save for retirement. Let’s consider the average annual US household expenses of nearly $73,000. Dividing that number by 4% tells us that a person would require an average of $1.82 million to retire comfortably. Sethi likes this rule because you can play around with the annual spending amount to design a realistic retirement plan. Although he admits there are a lot of caveats to calculating the retirement amount accurately, the 4% rule offers a good “back of the napkin number.”
Step 2: Prioritise 401(k) Investments
Tax breaks on capital gains and contributions, a relatively early penalty-free withdrawal provision, free money from employer matching, and high annual contribution limits make 401(k)s one of the most sought-after retirement plans in the US. Sethi views 401(k)s as among the most powerful retirement tools because of the hands-free investing experience and 100% employer matching options, sometimes up to 6% of your annual pay. He explains that if you start contributing 5% of your salary, assuming it is $3,000 annually, to a 401(k) at the age of 25 while fully utilising 5% employer-matching options (another free $3,000 annually), you will have $1.684 million by the age 65 if annual returns average at 8%. Without employer-matching contributions of up to 5% of your annual pay, the savings drops by 50% to $842,343. Hence, a 5% company match can double returns. Sethi advises you to contribute to your 401(k) monthly with at least an amount that utilises the full employer match.
Step 3: Clear High-interest Debt Before Investing
Sethi explains that any debt you carry with an interest rate higher than 7% directly competes with the money you invest for the future. He asks a simple question: Where do you think more money is going if you have $20,000 in credit card debt with a 26% APR and expect to earn between 7% and 8% from investments? Hence, he believes that paying off your debt is an investment in your future. High living costs due to rising interest rates to curb inflation have weighed heavily on US household budgets, pushing more people deeper into debt to sustain as delinquencies continue to grow. Easier access to credit via social media has also led many to rack up unnecessary debt. Sethi suggests that people in debt can save as much money as possible by first paying off the highest interest-rate loans.
Step 4: Invest In A Roth IRA
According to Sethi, as you free up monthly cash flow by repaying your debt, reducing monthly costs, or downsizing, you can put that extra money into a Roth IRA, even if you have a 401(k). One reason is that your 401(k) set up through your employer offers pre-set funds, which can sometimes have a high expense ratio. A Roth IRA allows you to invest in individual stocks, target-date funds, and index funds, among other investment instruments. The point is that you can pick low-fee funds in a Roth IRA that align with your goals so that you don’t lose a big portion of your hard-earned money towards fees that grow with your portfolio size.
While a 401(k) will grow your pre-tax contributions and your retirement withdrawals are taxable, a Roth IRA grows your post-tax money completely tax-free, and qualified withdrawals are not subjected to taxes. Sethi explains that you pay taxes on smaller amounts of money now, which is more affordable than paying higher taxes on capital gains and bigger withdrawals in retirement. If you have done well in your career, Sethi assumes you’ll be in a higher tax bracket during retirement, meaning paying more taxes to the government. However, it is important to know your annual income must be under the Modified Adjusted Gross Income (MAGI) limit of $161,000 or $240,000 for those filing jointly in 2024 to be eligible for contributing up to $7,000 in a Roth IRA. Sethi recommends investing in target-date funds via Roth IRAs offered by leading providers like Vanguard or Fidelity that charge low fees. When you invest in target-date funds based on the year you want to retire, the instrument automatically diversifies your investments based on age. Over time, fund managers automatically adjust your portfolio asset allocation to be more conservative to mitigate market risks.
Step 5: Maxing Out Your 401(k)
Sethi suggests putting effort into increasing your 401(k) investments to the 2024 contribution limit of $23,000 only if you have fully utilised employer-matching contributions in your 401(k) and maxed out your Roth IRA contributions. It would help if you maxed out your Roth IRA contributions first because you’d want to grow as much money as possible tax-free and without any tax liabilities on withdrawals. Once you have exhausted your Roth IRA limit, Sethi suggests putting the extra cash towards your 401(k). Since 401(k) contributions are tax-deductible, you can significantly reduce your annual taxable income and tax rate to free up more cash. However, you don’t need to report 401(k) contributions on your tax returns because your employer will have already lowered your taxable income on your behalf. If you can comfortably afford to max out your 401(k) contributions, Sethi suggests calculating the difference between the contribution limit and your actual contributions and breaking down the amount into monthly payments before setting up automatic monthly debits.
Step 6: Make HSAs Your Secret Investing Weapon
Sethi believes you can generate hundreds of thousands of dollars by opening and “supercharging” a health savings account (HSA). This account allows setting aside pre-tax money to pay for medical expenses, including deductibles, co-payments, and postpartum care, alongside traditional medical and dental spends. HSAs are often ignored because they are only available to people with high-deductible health plans (HDHP), which require you to pay a high minimum deductible of at least $1,600 before coverage kicks in. However, HDHPs often come with relatively lower premiums while the deductible varies every year. Sethi said that even people with access to HSAs need help understanding how to leverage the account to grow their money. AN HSA can become a powerful investment account because it lets you invest in stock and mutual funds. Furthermore, the triple tax benefits of contributing tax-free money, taking a tax deduction from annual income, and growing the money tax-free also offer a chance to create wealth faster with the power of compounding.
Step 7: Invest In A Non-Retirement “Taxable” Investment Account
If you have maximised your 401(k) and IRA contributions, cleared high-interest debt, and optionally invested in a HSA account, Sethi says there’s one more thing you can do next. He suggests putting any money left in a non-retirement “taxable” investment account. The biggest advantage is that there’s no limit to how much money you can contribute to the account, and Sethi believes many wealthy people have the bulk of their savings in these accounts. Moreover, taxable investment accounts offer a wide range of investment options for portfolio diversification, and there are no restrictions or conditions on withdrawal, unlike 401(k) and IRAs.
Sethi concluded by saying that while these steps offer a solid start to your retirement planning journey, there could be scenarios when you may need to consult a fiduciary financial adviser, like if you want to know exactly how much you need to save or want to model out different life scenarios for hedging financial risks.
Disclaimer: Our digital media content is for informational purposes only and not investment advice. Please conduct your own analysis or seek professional advice before investing. Remember, investments are subject to market risks and past performance doesn’t indicate future returns.
