Saving for Retirement

People can retire once they have become totally financially independent. Most people will never have the ability to be permanently financially independent, so most retirement plans focus on building temporary financial independence that will last as long as you do (or longer, so you have something to give to your children). In order to do so as effectively as possible, however, they invest as if they were building permanent independence. This means that the amount you save grows until you spend it - and what is left continues to grow. That is why you should save for retirement with things like mutual or index funds, because your money will extend as far as possible.

The advice given throughout these pages assumes that you will work a job that steadily increases or levels out in income for about 30 years. If you have a job that pays you a significant amount of money, but only for a short period of time, then your “retirement” savings should be as much as you possibly can save while you are working in order to create permanent financial independence instead of the way most people achieve retirement, through temporary financial independence (even if it is not enough for permanent independence, it is better to save way more so that you level out your spending across your lifespan). These jobs are things like being an actor in a TV show, touring as a musician, or joining BigLaw before you go into public interest.

Save before you Spend

The most important part of saving for retirement is saving before you spend. Whether you are paying off debt or building your nest egg, your savings should come directly out of your paycheck and should go into a fund that you do not pay attention to. That way, you learn to budget and spend as though you earn a lower salary than you do and you aren’t tempted to dip into your retirement savings for a cool new jacket or set of shoes - you learn to spend on those things with what is left, the money you have allowed yourself to spend on those things.

Maxing Out Employer Contributions

A number of years ago, retirement strategies switched from pensions to IRAs and 401Ks. Who Cares? Well, you should if you are going to be as smart about your savings as possible. New savings vehicles are set up through your employer and your employer will usually offer to match a certain percentage of your salary saved. MAX OUT YOUR EMPLOYER CONTRIBUTION. I cannot stress this enough. Getting your employer to contribute more money to your retirement savings is giving yourself a bonus for being responsible. Literally.

Paying off Debt

Much ink has been spilled on whether to pay off debt or save for retirement. The reality is, they are the same thing. Paying off debt is a type of savings - after all, it increases your net worth. (which, for the accounting nerds out there, is your personal assets minus your liabilities; paying off debts decrease your liabilities and therefore increase your total net worth)

The real question is how quickly to pay off your debts. And that comes down to a couple of factors. First, are you maxing out your employer contribution to your retirement savings? Do that. Second, do you expect to be in a new tax bracket in the next few years? Paying off debt is done with after-tax dollars, which means that you should pay off as much as you can while you are in lower tax brackets and focus tax-deferred retirement saving on higher bracket years. Third, are you able to afford food and clothes? If you are making your down payments on your loan, then you shouldn’t sacrifice your needs to pay it off more quickly, although it will benefit you to keep those needs budgeted tightly.

Ultimately, paying off debt versus putting more money into retirement savings often comes down to uncertainty versus returns. Most index funds have higher rates of return than debt does interest, but they also have more uncertainty. If you are extremely risk-averse, then you will want to focus your saving on your debt before you shift it to your Roth IRA. If you are more comfortable with risk, then you will probably get more overall by investing it in index funds.

If you are paying a mortgage on a house, then you also might be able to wrap student loans or credit card debt into your mortgage and get a tax deduction for paying it off. Ask your banker for the details on this.