10 Strategies to Save for Retirement on a Low Income

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By Emily Brandon

It's extremely difficult to save for retirement when you are only earning a small salary. The Senate Special Committee on Aging recently held a hearing about retirement preparedness, and witnesses shared ideas for encouraging saving. Try these strategies to boost your retirement savings:

1. Save by Default

It's important to make saving something you do automatically with each paycheck, rather than something you must take action to do each month. You can do this by setting up a direct deposit to a 401(k), IRA or other savings vehicle. "Automatic enrollment can be a powerful tool for increasing the number of Americans saving for retirement and other purposes," says Michal Grinstein-Weiss, an associate professor of social work at Washington University in St. Louis. "Defaulting to automation will ensure that Americans, particularly low income Americans, have a simple pathway to boost retirement savings."

2. Automatically Increase Your Savings Rate

If you start out saving a small amount, you will also need to increase your savings rate over time. "The default employee contribution rate should be set at a meaningful level and then increased until the combined employee contribution and employer match reach 12 percent of wages," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "The default investment option should be a target date fund comprised of a portfolio of low-cost index funds." Some 401(k) plans offer a feature that will automatically increase your savings rate over time. But if your 401(k) plan doesn't offer automatic escalation, you will have to make an effort to save more yourself.

3. Don't Stick to Your Employer's Savings Rate

Many workers are automatically enrolled in their 401(k) plan, typically at 3 percent of pay, but you will likely need to save more than that to fund a financially secure retirement. "Although the average 401(k) deferral rate is 6 percent to 7 percent, the most common deferral rate is 3 percent because that's where most employers auto-enroll their populations. Too often, it never budges from that mark," says Jean Chatzky, a financial editor for NBC Today. "Increasing contributions each year by 1 to 2 percent until a participant maxes out can literally double the amount of money an employee has in retirement."

4. Open an IRA

If you don't have access to a 401(k) at work or there's a waiting period before you can begin contributing, you can get valuable retirement saving tax breaks by opening up an individual retirement account. "Most economists will tell you that it is far easier to get people to save money for retirement through a payroll deduction at work instead of requiring them to open up an IRA on their own," says Senator Claire McCaskill. "The problem is that many low income workers face real structural barriers to saving: they work seasonal jobs, or are in and out of the workforce before they can vest or they work for employers who have neither the time nor the resources to offer a retirement plan." The IRA contribution deadline is April 15, and contributing shortly before you file your taxes can help you realize nearly immediate savings on your tax bill.

5. Make Smart Decisions When Changing Jobs

You will likely need to sign up for a 401(k) plan and set up new direct deposits each time you change jobs. It's important to make appropriate retirement saving elections at this time and to stick to them. "When starting a new position, employees are often asked to make retirement savings decisions that have a major impact on their retirement preparedness later in life," Grinstein-Weiss says. "Because people have a bias toward the status quo, those early decisions about retirement contributions are critically important."

6. Save Part of Your Tax Refund

Consider putting part of your tax refund into a retirement account. "For many low- and moderate-income households, the federal income tax refund is the largest lump sum payment received during the year," Grinstein-Weiss says. "After a household receives its refund, it is possibly in its best balance sheet position for the entire year and perhaps more open to saving than at any other point." IRS Form 8888 allows you to directly deposit your tax refund into a combination of checking, savings, or individual retirement accounts or to purchase Series I savings bonds.

7. Set Aside Separate Emergency Savings

Try not to use your retirement savings for anything other than retirement. "Unexpected financial shocks can affect a household's financial stability as well as its ability to save for long-term needs like retirement," Grinstein-Weiss says. "Without liquid assets to cover these financial shocks, households may rely on expensive and potentially harmful strategies, including skipping payment on bills, taking out payday loans, using other alternative financial services and liquidating retirement savings." It's important to maintain a savings account separate from your 401(k) or IRA that can be used for emergencies so you don't need to raid your retirement accounts early.

8. Start Saving Early in Life

Financial planners typically advise that you start saving for retirement at your first job, but recent research suggests that it's a good idea to develop a savings habit even earlier. "Studies also show that having an account in one's name as a child is positively associated with financial outcomes later in life," Grinstein-Weiss says. "It may be because they have already entered the financial mainstream and are able to continue engaging with financial products and institutions as they grow older."

9. Don't Withdraw the Money Early

Withdrawals from traditional 401(k)s and IRAs before age 59½ trigger a 10 percent early withdrawal penalty and income tax on the amount withdrawn. "About 1.5 percent of assets each year leaks out of 401(k) plans when participants cash out as they change jobs, take hardship withdrawals, withdraw funds after age 59½ or default on loans," Munnell says. You can avoid the taxes and penalty when you change jobs by leaving the money in your old 401(k) plan, moving it into the 401(k) plan at your new job or rolling it over to an IRA.

10. Avoid High-Cost Investments

Similar types of investments often charge vastly different fees, and unnecessarily high costs can significantly reduce your retirement account balance. "Many individuals make investing missteps, such as putting their money in mutual funds with high fees, which can substantially shrink their assets over time," Munnell says. "For example, an additional 100 basis points in fees over a 40-year period reduces final assets by about one fifth." Pay close attention to the expense ratio and other fees charged by each investment option and choose low-cost options when they are available.
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