Saving for retirement is especially difficult when you are earning a small salary. But tucking away even a small amount might qualify you for tax breaks, an employer match and will get compound interest working on your behalf. Here’s how to begin building wealth for retirement when you have a low income.
Get help from your employer. A 401(k) match or other type of employer contribution is likely to be the fastest way to build wealth. If your company will provide 50 cents for each dollar you save in the 401(k) plan, that’s a 50 percent return on your investment. A dollar-for-dollar 401(k) match will double your money.
“That’s actually part of your salary, so you should absolutely be taking advantage of that,” says Denise Downey, a certified financial planner for Financial Trex in Spokane, Washington. “If it isn’t automatically taken out of your paychecks, it’s easy to come up with a reason not to save every month.” Find out how much you need to save to get the maximum possible 401(k) match and make every effort to deposit that amount in your retirement account.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
Qualify for tax breaks. You can defer paying income tax on the amount you contribute to a 401(k) or IRA. If you are in the 15 percent tax bracket and contribute $1,000 to an IRA, you will save $150 on your current tax bill. Income tax will not be due on that money until you withdraw it from the account.
Claim the saver’s credit. In addition to the tax deduction for saving in a 401(k) or IRA, low and moderate income workers might qualify for the saver’s credit. Employees whose adjusted gross income is below $30,750 for individuals and $61,500 for couples in 2016 are eligible to claim the credit, which is worth between 10 and 50 percent of retirement account contributions up to $2,000 for individuals and $4,000 for couples. For example, a worker who earns $30,000 and manages to put $1,000 in a 401(k) could get a tax credit worth $100.
[Read: Retirement Planning Decisions You Might Later Regret.]
Consider a Roth account. A relatively low income usually means you pay a lower income tax rate than people who earn more. If you save in an after-tax Roth IRA or Roth 401(k), you can lock in your current low tax rate and set yourself up for tax-free income in retirement.
A Roth IRA can be especially beneficial if you expect to be in a higher tax bracket in retirement. For example, let’s say you save $1,000 in a Roth IRA and pay 15 percent tax, or $150, on the contribution. After age 59 1/2, you will be able to withdraw that money and the investment earnings without having to pay income tax on it. If you saved that same $1,000 in a traditional IRA, you wouldn’t have to pay the $150 in taxes on it upfront. However, if your Social Security income and retirement savings put you in the 25 percent tax bracket in retirement, you would have to pay $250 for income tax when that $1,000 comes out of the retirement account.
“If you are in a low tax bracket now, typically you are going to be in a higher tax bracket as you get older,” says Steve Taylor, a certified financial planner and president of Colt Financial in Franklin, Massachusetts. “You would pay less tax now, so it would make sense to be contributing to a Roth that gives you that ability to be tax-free when you are in a bigger tax bracket.”
Check out the myRA. America’s newest retirement account, the myRA, has only one investment option: a U.S. Treasury retirement savings bond that is guaranteed never to decline in value. The account is aimed at those who don’t have a 401(k) account at work, but it is open to most workers with earned income. The myRA accepts small contributions and doesn’t have any low-balance fees. You can contribute via payroll deduction, direct deposit from a checking or savings account or redirect your tax refund to the account. “It’s very simple to set up and convenient,” says C. Bradley Bond, a certified financial planner for C. B. Bond Financial Planning in Export, Pennsylvania. “It invests in U.S. Treasury securities, and it’s paying about 2 percent now.” However, you aren’t allowed to accumulate a large nest egg in this starter retirement account. Once your balance hits $15,000 or the account turns 30 years old, you will be required to transfer your savings to a Roth IRA.
[See: 10 Retirement Planning Moves to Make in Your 20s.]
Have the money withheld from your paycheck. If you know you won’t stay motivated to save for retirement every month, have the money withheld from your paycheck before you ever get a chance to spend it. This usually happens automatically when you sign up for a 401(k) plan, but you can also elect to have part of your paychecks directly deposited into an IRA or myRA. Alternatively, you could set up recurring transfers from your checking account to a savings or retirement account. “Saving $20 per month sets a healthy habit in place, and you are living below your means,” says Julie Ford, a certified financial planner for Ford Financial Solutions in New York. “If you are putting money into the market and investing for the long term, you are going to see that amount of money slowly grow over time, and that is really encouraging.”
Emily Brandon is the author of “Pensionless: The 10-Step Solution for a Stress-Free Retirement.”
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How to Save for Retirement on Less Than $40,000 Per Year originally appeared on usnews.com
