When most people start on their retirement savings journey, the path can seem straightforward. However, life often throws up obstacles along the way. Understanding the impact of those pitfalls can help your retirement investors make more informed decisions as they look to make the most of their retirement savings journeys.
Keep your retirement investors on track with long-term goals with the following areas to consider:
Balance saving for retirement and paying down student debt. If you are a new graduate entering the workforce, you might face a difficult decision: how will you balance paying back your student loans and saving for retirement. Consider creating a budget to determine how much you can afford to save for retirement and look to take advantage of an employer’s matching contribution while paying down your student debt. Saving for retirement early in your career can have a significant impact on your retirement account balances due to the power of compounding of investment returns.
Small increases in savings can make a big difference. One way to ramp up your savings is by allocating some of your pay raise towards higher saving amounts in your retirement plan. Over a long time horizon, additional savings, plus the compounding of market gains, if any, have the potential to really add up.
Understand the impact of leaving the workforce. Many people need to leave work for a period of time to care for family members, such as children or elderly parents, yet they don’t always know how these breaks could impact their retirement savings. When you leave the workforce, you generally forego your own contributions to your workplace retirement plan, plus matching contributions, if any. Unfortunately, these disruptions can have a substantial impact on retirement savings and income in retirement. If you go back to work, increasing contributions to your retirement savings or delaying retirement might help to offset your years away. If you leave the workforce permanently, your partner could increase his or her contributions to retirement savings. One of the best ways to deal with unexpected breaks from the workforce is to save as much as you can afford in your early working years to try to build your retirement savings as much as possible.
Think twice before taking a loan from your 401(k). During uncertain financial times, it can be tempting to take a loan from your 401(k) account. Unfortunately, taking a loan can have long-term implications for your income in retirement. While you do repay the loan with interest to your account, you may miss out on market appreciation, if any, on the amount you borrowed, and even small amounts compounded over time can have a big impact on your savings. In addition, you may have to pay higher taxes, as loan repayments are typically made with after tax dollars. Before tapping into your retirement savings, see if there are other assets that you could use.
Save for health care in retirement through an HSA. The cost of health care is one of the biggest expenses facing retirees. While Medicare provides basic health insurance, premiums, out of pocket expenses, deductibles and coinsurance can be significant costs in retirement. Also, Medicare does not cover dental or vision benefits, and typically does not cover those under age 65. While every situation is different, a recent study estimated that a married couple could need as much as $361,000 to cover health expenses in retirement.1 Fortunately, in addition to workplace retirement accounts, health savings accounts (HSAs) can help you save and invest2 during your working years and looking to provide some relief when it comes to health care expenses in retirement.
HSAs can provide a triple tax advantage: contributions are made pre-tax, there is no tax on investment returns and distributions are not taxed if they are used for qualified medical expenses. In addition to their triple-tax advantaged status, there is no “use it or lose it” rule, so your HSA can grow over time and you don’t have to make use of it until you want to. It is important to look at the features and risks involved with HSAs, and all investing involves risk, including risk of loss.
Keep calm during volatile markets. Bear markets and volatility can be unsettling. While you may be tempted to reduce your contributions or move your assets to low-risk investments, those decisions can get in the way of building wealth. Market research shows that when investors try to protect their portfolios by moving in and out of the market, they often limit gains and increase losses. While taking a long-term view can be challenging, moving to cash may mean that you miss out on potential market rebounds and while stopping contributions may relieve some anxiety over the short-term, think about how you’ll feel in retirement if your savings don’t meet your income needs.
Choosing between college savings and retirement savings. Saving is not always easy and often comes with competing demands, such as saving for retirement or your children’s education. However, it doesn’t have to be an either/or scenario. Perhaps you could reduce your contribution to your retirement savings by 2% and earmark that 2% to a college savings account. There are tax-effective ways to save for higher education, such as a 529 savings plan which defers taxes on investment earnings and offers withdrawals free of federal taxes if used for qualified education expenses.3 A key to working towards achieving savings goals often comes down to saving as much as you can as early as you can.
Deferring your retirement age can help manage income potential. While good saving and investing habits are critical components of retirement income, one of the most powerful tools you have is deciding at which age to retire. Working longer gives you more time to save, more employer contributions, if any, and more time for your savings and matching contributions for growth potential.
Your retirement savings is only one part of your retirement income. Your Social Security benefit is another. While Social Security benefits can begin at age 62, by waiting to take your benefit, your benefits grow each year until age 70. Deciding when to retire is a personal decision and working longer is not always possible. However, consider weighing the pros and cons of working longer as a part of the retirement planning process.
Looking to strike a balance between risk and income in retirement. As you move through your journey, asset allocation plays an important role. A general rule of thumb is to invest more aggressively when you are young and invest more and more conservatively as you approach and move into retirement. For example, equities have more total return potential than bonds but carry more risk of loss so younger savers have time to recover from a market decline and hopefully continue to build wealth. Savers close to retirement may have less time to recover from a loss before they start withdrawing, which could mean running out of money in later years. As savers get older, adding conservative investments such as bonds may help manage risk and potential losses.
1EBRI Issue Brief, January 13, 2022 assuming 90th percentile of drug expenses throughout retirement.
2Most HSA providers allow for assets to be invested in a range of stocks, bonds, mutual funds and ETFs
3 You will be subject to federal income tax, and a 10% federal tax penalty may apply on earnings if amounts are withdrawn for something other than qualified education expenses.
Keep in mind that no investment strategy can guarantee a profit or protect against a loss. All investments, including mutual funds, carry a certain amount of risk, including the possible loss of the principal amount invested.
This material is provided for general and educational purposes only and is not investment advice. The investments you choose should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities or investment related service or product, including any investment product or service described in these materials.
MFS® does not provide legal, tax, social security, or accounting advice. Any statement contained in this communication (including any attachments) concerning U.S. tax matters was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. This communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed. Clients of MFS should obtain their own independent tax and legal advice based on their particular circumstances.
MFS Investment Management is an American-based global investment manager, formerly known as Massachusetts Financial Services. Founded in 1924, MFS is one of the oldest asset management companies in the world and has been credited with pioneering the mutual fund.