Today we have a post from Shannon, a regular contributor.
If you asked this question from the general financial services population, the typical answer you would get is “As soon as possible.” When my client’s ask me this question, they get a completely different answer, and let me explain why.
Like most people under 40, I was hit over the head with the fact that social security will probably not exist for me when I retire, or if there is anything left, it will not represent the significant contribution to retirement that it does for most recipients today. I am typically a fearful person, so the fear of having no money when I reached retirement freaked me out. Because of this fear, I started saving for retirement aggressively the second that I started working.
There Is More than Retirement to Consider
Now, the general financial services population would have been so proud of me for committing to retirement when I was 22. I was giving myself the greatest gift I could possibly imagine. There is only one issue with this. For most people my age, retirement will likely occur around 70, which is close to 50 years after I started my job, two lifetimes from what I already lived. And all of this money that I was putting into retirement accounts, is really intended for just that because there are all sorts of penalties and taxes should I take the money out before the designated retirement age.
Two lifetimes is a lot of life to live between here and retirement. When I meet with clients (most of whom are between 22 and 35), the way I describe their retirement money is their “moon” money. I tell them that they should think of this money as easy to access as the moon. So they are working and on a journey to the moon, but that journey’s destination is not nearby. And the problem with putting too much money on the moon is that you have a lot of life to live between here and the moon.
It’s a Long Journey…Make Sure You Are Prepared
Most of my clients have a number of life goals that they want to achieve between here and the moon, they want to get married, buy a home, have children, travel, get higher level educations, give to charity, work in a job they love. And all of these goals cost money. And if that money is on the moon, it is not going to help them while they are trying to achieve their dreams on Earth. I sit and look at my retirement account as an astronaut would look up to the moon. I am in awe of it’s size and dream of one day visiting it, but the dreaming is filled with sadness that I am not there yet. I don’t like to see other people feel this way.
So, what am I saying? To not save for retirement? To not plan for the moon? No, I am a blonde, but I am not dumb. I understand all of the tax benefits of saving for retirement, I understand company matches or “free money,” and I understand compounding interest and investing. The thing is, I also understand that we have a lot of life to live that requires money to live it, so instead of preparing for the moon, I prepare clients for life.
Separate Your Assets Into Categories
I view assets in three buckets, emergency money, moon money and then in the middle is life money. I train my clients to manage their lives so that they are capable of saving the maximum amount possible given their expenses. Once this money is saved, we view it as a waterfall type funding process.
The first stop is making sure that they have enough saved in their emergency account should any issues arise in the next year. After that is funded, we look at their life goals and how imminent they are from today. If they are planning to buy a home or pay for a wedding, then we make sure that we have enough in the life bucket to help cover these expenses. And then when we know that those first two buckets are in good shape, we focus on the moon money.
There are certainly caveats to this process depending on employer based retirement plans, etc. and we definitely invest the life money and sometimes some of the emergency money depending on goals and assets, but the important message I like to give anyone under 40 about retirement is that yes you need to plan for it; however, you need to plan for life first. I hate to see clients get into credit card and debt troubles because they didn’t have enough cash to cover emergencies or life events. Or I hate to see clients lose almost 50% of their retirement savings because they needed to take an early withdrawal to cover a life event as well.
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All of the money you save, invest and grow during your lifetime will eventually flow over into your retirement. So instead of asking when do you start saving for retirement? Ask “When should I start saving for life?” and the answer to that question is immediately and as much as possible. Your life savings is the fuel for your journey around Earth and eventually the moon. The more fuel you have, the more you will be able to see and enjoy of the trip.
What is your retirement savings philosophy? Do you know someone who took money out of a retirement account early to fund a life event?
Photo by Simon Cunningham
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I love the moon analogy. Something everyone can relate to. I have never taken money out of a retirement account and I don’t think I ever would. That would be very last resort- after all, I have plans for the money to take care of me in retirement!
when I first started working in public accounting I received a project to project the tax consequence for a client who was considering taking an early withdrawal on their retirement account. After doing the math myself, I realized how bad that is. Fed income tax rate + state income tax rate + 10% fed penalty ended up consuming nearly half of the theoretical distribution. I never heard if this client decided to make the distribution, but this exercise taught me a great lesson: Avoid early distributions at all costs! I know there are a few exceptions but on a general note stay away!
When do you start saving for retirement? Now. No matter what age you’re at, Now is the time. :) We used a 401K loan at one point during the last 4 years of paying off $109,000 of credit card debt – it seemed silly to be struggling daily with making our ends meet when we could do some additional consolidation, and make our lives immensely easier. As for using retirement to fund a trip, or other discretionary items, I’ve never done that.
colormefrugal Yes, the moon analogy definitely helps my clients frame their savings tactics and gives them a good idea on how much they can and should allocate to that bucket of money.
BudgetforMore I know! Early distribution penalties wipe away any of the potential initial tax savings, so you need to have a really good plan for avoiding those.
DebtChronicles A 401K loan is definitely better than an early distribution if you really need the funds. Typically when I see people take money out of their retirement accounts it is usually to cover emergency money needs which always seem to arise.
I definitely need to start saving some money for my “in between”. Luckily (or unluckily) my personal life isn’t looking like it’s going to need any major financing in the form of weddings or babies any time too soon though ;)
I love the analogy Shannon! I wish I would’ve started much earlier with my investing, but debt has a funny way of keeping you from investing at times. :) That said, I think the balanced approach is a solid one to take. Yes, saving more is generally good, but you don’t want to do it to the point that you’ve opened yourself up to major risk because you have nothing set aside for other events that might come up.
When I was going through a lot of financial trouble, when my bank account got severely low, I considered myself “broke.” BUT, I still had money in retirement accounts I was not touching, so I really wasn’t broke, but that is my mindset because that money is totally off limits. I know a lot of people who have used retirement savings for things they probably shouldn’t have. And now they are almost truly broke with no moon money.
brokeandbeau Ha! Yes, even if your major financing is not in the immediate future, it definitely makes sense to plan for it so it causes less of a financial strain when it does happen.
FrugalRules Life is definitely a balancing act John, and yes, I hate to see people commit too much to one area and then open themselves up for major risks down the road in others.
Beachbudget I am with you Tonya on the retirement mindset! But yes, the worst thing is taking money from retirement and not making up for it, which usually happens. Once the money comes out, it rarely gets built back up in another area.
I’m glad I started saving early…started contributing into my deferred compensation plan at work right out of college and opened an IRA. I know many of my peers who thought they couldn’t afford save anything for retirement or just weren’t too worried about it. And others who saved but would often take money out to pay off their credit cards. If my wife and I buy a place, I might take a loan from my 401k. I know that is usually not a good idea but a downpayment in the NYC area is hard to reach without taking that loan. Plus I work in government and also have a pension so I feel more secure in taking that loan.
I think that’s why it seems so hard to make my 401k contribution every month.I never had to think about it before I was totally self employed because it automatically was deposited from my paycheck. Now I have to manually do it myself. It feels like that money is gone, but I have to keep reminding myself that it’s still my money and it’s much better there than leaving it in a savings account or spending it on something I don’t need.
I think this is a great plan to attempt to have balance in savings. My old job involved working at a place that gave funding to small businesses. There were so many business owners willing to take the money needed out of their retirement fund, because they thought the interest was too high, or that the process was too complicated. It amazed me!
Andrew LivingRichCheaply A loan from a 401k is definitely better than taking the money completely out. And yes, starting the savings process early is the best strategy.
Eyesonthedollar It is definitely hard to save when it is a manual process, but good for you for committing to it!
JourneytoSaving A lack of balance definitely led those business owners to the decision they were making.
Oooh! I love this way of looking at things. It makes me feel not as bad for the small contribution I make to 403b (which is on top of a state retirement plan). There are other ways to invest money aside from money that I won’t see until I’m half way to dead. Oh my gosh did I really just say that!! But the idea of working until I’m 70 is pretty dang depressing.
Great post, Shannon. We all need to save for retirement but there are so many others thing we want to experience and/or have before we ever retire that we need to save for as well. It’s why goal-setting is so important. When you’re in your 20-30’s retirement is a bit hazy. You may know when you want to retire but how you will spend your time isn’t fully formed, so you’re saving for the future and the time when it will be more crystalized. Meanwhile, like you said, you want to buy a home, have kids and spend them to college, pay for weddings, travel etc. So it’s important to understand how to allocate your money -what should go to retirement and what goes towards your other goals. Because i know that I definitely want to enjoy now and not have to wait until I retire.
I don’t want my journey to the moon to be like that of Apollo 13 –
marked by emergencies, stress and crises I can’t handle. Focusing on the
destination is a must, but I want to enjoy the journey along the way.
I did take out a loan from my 401k to help with the purchase of my first home. As you probably know, this is different than a withdrawal and is offered as a benefit from some employer-sponsored plans. We can debate about whether you should EVER take out a 401k loan but it’s greatly benefited us as housing prices, especially where our house is located, have risen quite a bit over the past year and a half. That’s not even taking into consideration the equity we’ve been building or the cash flow we’re receiving from renting out the basement. I think taking a loan out for something like this can justify the loan, though I would agree that not taking out loans are generally a good idea.
PinkSunshine94 Ha! It is sad to think of working until you are 70, especially if it is two lifetimes away. That’s why we just have to take things one day at a time and make smart financial choices along the way so that hopefully we won’t have to wait that long to retire.
ShannonRyan I am with you Shannon! You don’t want to wait forty years to enjoy your hard work and the best way to do that is to have a balance on where you put your money.
Brian @ Luke1428 Ha!! I hear you, Apollo 13 is a moon mission we should all avoid creating in our financial lives. :-)
DC @ Young Adult Money I would definitely suggest a loan over a complete withdrawal and you are lucky your employer allows the loans as some plans do not. The good news about the 401k loan is that typically the interest you are paying is to your own account and not the administrator so at least you are paying yourself along the way.
I am also glad that I started saving at age 22. I’m only four years in, but I can see the money getting bigger and bigger. Now that I am going to freelance, I see the need to be careful about my finances even more!
fitisthenewpoor Yes! No matter where you put your money, it is definitely best to start your savings mentality early, then it just becomes a “habit” and it’s a great habit to have.
I began saving for retirement when I was 22, and I’m grateful that I got with the program and started early. I have a head start and a few more years to take advantage of compound interest. I just wish that I’d contributed more to my retirement accounts back then. I started off slowly.
Honestly, I just started saving for my retirement. At first, it’s very difficult for me, but I realized that being consistent on your savings would be a very good thing to do.
PrairieEcoThrifter Good for you for starting to save early! And yes, we all have financial regrets, but we can always improve ourselves too.
Clarisse @ Make Money Your Way It really is the process of creating a consistent savings mentality that is important over everything. Good for your for starting it!
I find the little retirement calculators awesome to motivate you to save for retirement as soon as possible. Even small sums make a big difference if you start young.