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Let’s Ask Morningstar: Late-Start Retirement Saving Tips

December 2, 2015
Get late-start retirement tips that also respect your risk.

As with many of life’s long-term goals, it’s never too late to start saving for retirement. But a late start to retirement savings—we’re talking about a couple of decades or more into your career—may require some aggressive action.

The key to retirement saving catch-up is learning how to accept some increased risk in order to optimize potential returns, but without being so aggressive that if the economy and/or the stock market should sour at the wrong time—say on the eve of your retirement—all that you’re working for might be wiped out.

Here we share some insight from Christine Benz, director of personal finance with Morningstar Investment Management and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. You can follow Christine on Twitter: @christine_benz.

(The following, originally published by Morningstar, has been edited for length.)

Do: Be prepared to take some risk.
The key attraction of cash and high-quality bonds is that they're less volatile than stocks. But that peace of mind comes at the cost of lower returns. Thus, accumulators who need their retirement assets to grow have no choice but to steer a healthy share of their portfolios toward stocks, letting their time horizons determine how aggressive they go. For example, the Moderate version of Morningstar's Lifetime Allocation Indexes, for someone aiming to retire in 2025, features a hefty 60% stock weighting. Investors who are nervous about the volatility that such a large portion of stocks entails might consider buying an all-in-one fund, such as a target-date vehicle. By mixing both stocks and bonds and reporting their combined performance, such funds help camouflage the visible performance bumps that inevitably accompany a stock investment. 

Don't: Go too aggressive.
It can be a mistake for older workers to swing for the fences in an effort to make up for a shortfall. Even if you plan to keep working for the foreseeable future and think you can tolerate the downturns that are apt to accompany stocks, there's a chance that you may need your money sooner than you expected. And if all of your money is parked in stocks, you run the real risk of needing to tap your principal while stocks are way down. That could permanently impair your retirement plan. That's why even risk-tolerant investors in their 50s and 60s should prioritize an emergency fund to help stave off portfolio withdrawals. 

Do: Take advantage of catch-up contributions.
Workers over 50 have the opportunity to give their retirement plans an extra shot in the arm by making so-called catch-up contributions: an additional $1,000 annually to their IRAs and an additional $6,000 for 401(k)s, 403(b)s, and 457 plans. Thus, savers over 50 can contribute $6,500 to their IRAs for the 2015 tax year and a full $24,000 to their company retirement plans. It's also important to note that retirement savers are eligible for those catch-up contributions on January 1 of the year in which they turn 50.

Don't: Stop with IRA and 401(k) contributions.
Although making the maximum allowable contributions to IRAs and 401(k)s is a worthwhile goal and an enviable achievement, higher-earning, late-blooming accumulators shouldn't stop with maxing out those accounts. Health savings accounts, after-tax 401(k)s, and spousal IRAs serve as additional receptacles for tax-sheltered retirement savings. 

Do: Count on your own contributions, rather than market returns, to do the heavy lifting.
U.S. stocks have had very robust returns in the last five- and 10-year periods, respectively. But those sorts of returns are far from guaranteed. Heightening contributions can help offset the risk that market performance is lackluster in the years leading up to retirement. For example, say you were adding $15,000 a year to your $100,000 portfolio for 15 years and you earned a reasonable 5% rate of return. You’d have $531,000 at the end of the period, roughly in line with the return if you had saved $10,000 for 15 years and earned a robust (but arguably less realistic) 7% return on your money.

Don't: Forget to play small ball.
Yet, even as bumping up your savings rate is a surer way to improve your portfolio's viability than is gunning for a better investment return, small-bore factors can help move the needle, too. Morningstar frequently evangelizes about the benefits of limiting your portfolio's total costs by opting for low-expense investments and limiting transaction fees, as well as keeping an eye on tax costs by maximizing tax-sheltered investments and paying attention to asset location and tax-efficient withdrawal sequencing

Do: Factor in taxes when determining portfolio sufficiency.
After a six-year bull market, retirement-account balances are, in many cases, looking comfortingly plump. But it's important to take any taxes into account when determining the sufficiency of your nest egg. If most of your assets are in tax-deferred accounts like traditional 401(k)s and IRAs, you'll pay ordinary income taxes on those balances, provided you haven't put in any after-tax money. Someone in the 15% tax bracket would see her $300,000 401(k) portfolio balance shrivel to $255,000 once taxes are factored in, for example.

Don't: Reflexively reach for Roth accounts.
Knowing that traditional IRA and 401(k) assets will be taxed upon withdrawal might seem to burnish the appeal of Roth accounts, which allow tax-free withdrawals. And for many investors, getting at least some assets over into the Roth column is a worthy goal. But paying taxes on your contributions—as Roths require you to do—isn't advisable if you think your tax bracket may be lower in retirement than it is during your working years. You're better off taking that tax break on your contribution to traditional 401(k)s and IRAs (if you're eligible for a deduction) instead of getting that tax break later on, when it's worth less. Moreover, if you're playing catch-up on your retirement nest egg, you probably won't benefit from one of the chief advantages of Roth IRAs—the ability to avoid required minimum distributions—because you'll need to tap your IRA for ongoing living expenses. 

Do: Consider working longer as part of your retirement plan.
Working longer is one of the most powerful things you can do to help make a save if you're hurtling toward retirement but haven't yet amassed much in assets. While many individuals may not relish working past the usual 65, delaying retirement offers a valuable financial three-fer: continued investment contributions, delayed portfolio withdrawals (which can greatly improve a portfolio's longevity), and the potential to claim Social Security later. 

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The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.

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