Now, Create a Retirement Fund

You have paid down your debts. You have built an emergency fund. Now for the part that usually comes to mind when you hear the words “planning for retirement”: Create your retirement fund.
You know that you need to save for retirement, but it seems tough. There is some good news. The government gives tax breaks to help you save for retirement. Your employer wants to help you save for retirement. You have years for your retirement account to grow, which means that a little savings goes a long way. In other words, this is really easy. You just need to do it.
• Sign up for your retirement plan at work. You’ll get automatic tax breaks for every dollar you put in, so the government gives you an immediate boost. (You may have a plan that gives the tax break when you retire rather than with your contributions.) And your company may give you matching contributions, which really is like free money lying on the table. So be sure you reach over and pick it up.

• Create your own retirement plan: If your boss doesn’t offer a retirement plan, open an IRA (Individual Retirement Account) on your own. (If you are self-employed or if you run a small business, open a SEP-IRA or an individual 401(k), both of which offer higher savings limits and extra tax breaks to small business owners.) IRAs are easy to set up;  you can open one through your local bank or through an online financial institution.
Look for an IRA that has low fees and plenty of investment options. Once you’ve
opened your account, just start contributing. The government will help you fund your IRA by chopping down your taxes, so take advantage of it—it’s like walking around with a bucket when it’s raining money.
How much should you put in your retirement accounts? Roughly 10 percent of your take-home pay. If your employer contributes to a pension or savings plan, you can put in less; if you are over 35 and you are just getting started on saving for retirement, you should put in more.
Once you have put some money in your retirement fund, sit back for a minute and congratulate yourself. Half of all Americans never make it this far. If you have a retirement account and you are putting money in it, then you have just made it into the upper half (financially speaking) of all adults in the U.S. Congratulations!
So how do you build your retirement savings? A little at a time. Think of it this way. How do
you eat a huge meal? One bite at a time. How do you make a long trip? One mile at a time.
How do you build a big house? One brick at a time. You wouldn’t say, “I can’t possibly eat the
whole meal!” or “I’ll never get to Milwaukee!” You would just keep at it, one step at a time—
and not think much more about it.
Okay, you already know this. So here’s the next question: How do you get half a million dollars
in your retirement account? Here’s a hint: The answer is not “Win the lottery” or “Inherit a
bundle from a long lost uncle.” The answer is that you will get $500,000 by saving a little at a
time. Save, and keep on saving, and you’ll make it sooner than you think.
Still not persuaded that you can build that mansion one brick at a time? Maybe the math will
convince you. Suppose you earn $50,000 a year. Now suppose you stick with your retirement
plan, setting aside roughly 10 percent of every paycheck for your future and investing it sensibly.
In 15 years, you’ll have more than $130,000. And in 25 years, you’ll have nearly half a million
dollars.
Take a look at the table, which shows you how much your savings can grow if you put aside 10
percent of your paycheck.

Now that’s a smart financial move.

But what about the mortgage interest tax deduction? A tax deduction is no reason to prolong your mortgage payments! Think of it this way—if you were a professional gambler, your gambling losses would be tax deductible. But does that mean a gambler wants to lose money? No way! Still not convinced? Consider the math. Let’s say you are paying $1,000 a month towards your mortgage; $700 goes to interest and $300 goes to principle. You would save around $175 on your taxes. So you want to keep paying $1,000 to the bank so you can save $175? 

Of course not. Math like that will drive you to the poorhouse in a hurry. As a friend of ours once said, “The problem with tax deductions is that they are like paper towels. You have to spill your own milk (make the payments) before they help you sop up some of it.” But what if you plan to sell your house? If you sell your house, you walk away with the equity—and the equity increases for every dollar you pay down on the mortgage. 

When you sell the house, the cash is yours, whether you plough it into another home or just shove it in your pocket. But doesn’t it make sense to borrow against your home when interest rates are low? Whether you are borrowing to pay down your credit card balance, play the stock market, or travel to Tahiti, borrowing against your home is still borrowing—period. It is not saving, it is not smart, it is not savvy. A second mortgage or a home equity line of credit is dangerous, because it gives the mortgage lender the right to take your house away if you get behind on your payments. 

So just pay down your mortgage, and bask in the knowledge that one day you will be completely, contentedly debt-free. But what if you don’t own a home? Should you rush right out and buy one? Should you decide your future is hopelessly lost forever and crawl into your apartment bathtub and pull a mattress over you? No and no. If you don’t own a home, it may make sense to buy—or it may not. Buying a home is not the right choice for some people. 

And renting is perfectly fine—on one condition: Renters still need to keep saving. The money you would have used to pay down your mortgage should go into your savings. If you’re not a homeowner, you will need extra money when you retire so you’ll be sure to have enough to cover the cost of an apartment.

Fourth, Pay Off Your Home

Imagine a home of your own. Not just a house that you live in, but a home that is all yours. No mortgage payments, no rent checks. A home that is completely, 100 percent paid for, free and clear. Yours. Sixteen years ago, Stephen Acosta broke his back in a motorcycle accident. He was lucky to regain the use of his arms and legs, but his days climbing around on construction sites as a licensed electrician were over. Between the medical bills and the lost income, he was pretty much wiped out. He was just out of rehab when his house was posted for foreclosure. Stephen got a repair job in an electronics shop, and then took a second job working weekends as a security guard in a downtown office building. He cut his spending to the bone, and pretty soon he was caught up on the mortgage. “I kept picturing that orange sign on my front door, saying someone else was gonna take my house. 

And every time I thought about it, I got mad all over again, and I sent another hundred bucks to the mortgage company. I figured they could take my whole paycheck, but I’d never let them take my home.” Three months ago, Stephen threw a big party. He invited all his friends, and his mom came, too. After everyone arrived, he thumped his fist on the table, telling everyone to be quiet because he had an announcement. 

All eyes turned to a big green bowl with some papers in it. Stephen explained that this was his mortgage, he had paid it off and gotten it back from the bank, and he wanted everyone he loved to witness while he burned it. “Everyone cheered while I fired it up. Then my mom cried, and I even choked up a little. I pulled myself out of a hole and now this place was mine forever—no matter what.” Sound good? The fourth step in your lifetime money plan is to create a plan to pay off your home. Paying off your home is the double win in the savings world—a tremendously smart financial move that is also tremendously satisfying. After all, where else can you build substantial wealth and smile over your flower bed, all at one time? Paying off your home is a great part of your retirement plan. When it comes time to retire, you can live rent-free, which means that your Social Security and retirement savings will go a lot further. If you end up in a situation where you need a lot of cash, you can sell your house and move to something smaller. And if you stay in your home until your last days, the house will be a wonderful legacy to pass along to your children or to your favorite charity. Paying off your home also does something many financial planners neglect to mention: It gives you freedom. Once that mortgage is gone, just imagine all the freedom in your wallet. Freedom to spend more money on fun, freedom to give more to the people you love, freedom to work a little less and play a little more. Think of this as yet another form of sleep tight insurance. How do you pay off your home? A little at a time. Squeeze out some extra money from your monthly spending and put a second check in with your mortgage payment (about five percent of your take-home pay is a good target). Or if you get a Christmas bonus, put it toward paying off your mortgage. If your mom gives you money for your birthday, or if you get some unexpected overtime pay, put it towards your mortgage. There are lots of ways to do it, but the main thing is to begin. The goal is to chip away at your mortgage, so that you pay it off faster. If you keep making the extra payments, you can get your mortgage paid off years ahead of time—all while saving yourself tens of thousands of dollars.

Third, Build Your Emergency Savings

The third step in getting your financial house in order is to build your emergency savings. This is your safety cushion, the money that will stand between you and the things that can go wrong. You can call on your emergency savings if your car’s transmission goes on the fritz or if you get sick. It is there so you always have a cushion in your account, so you never, ever have to pay another bounced check fee. It is the ultimate “sleep tight” insurance, since it gives you the confidence that you can handle whatever life throws your way. 

Having money in emergency savings is the guarantee that you won’t have to slip back into debt. This is how you make sure that the little things that go wrong in life are just that—little. 

You can manage life’s bumps and bruises without raiding your retirement account or relying too much on your credit cards. The goal is to build a nice, comfortable bank balance—enough money so you can be really and truly confident about your money. Aim to save about three months pay. You don’t need anything fancy, just an ordinary savings account you can tap whenever you need it. This is the money that lets you rest easy, because you know you will be able to handle pretty much anything life throws your way.

Here are some common traps to watch out for:

If it seems like a long road to pay off all your debts, just remember this—you are not just paying off your debt, you are building a brighter future. Getting these debts paid off will change your whole outlook, making each step a little lighter—and your future a whole lot more secure.

Where do you get the money?

Here is where it pays to keep your must-have expenses in balance. If you are spending about half your money for the basics—mortgage, car payment, insurance, and the like—then you have roughly half your salary left over for everything else. This means you should have plenty of money to cover stuff you want (but don’t absolutely need), like new clothes and an occasional restaurant meal, and money to start getting caught up on your bills. A good guide is to earmark 20 percent of your paycheck to debt repayment and savings. When you balance your bills, you will have money left over to repay debts and begin saving. There are no short-cuts and no quick fixes. So beware of traps “to get out of debt quick” because they can end up costing you more money in the long run.

Second, Pay Off the Debt

The medical bills from last year’s visit to the emergency room. The money you borrowed from cousin Charlie that has been hanging out there for over a year. The credit card balance that has bounced around for more than a decade. You don’t need a scrapbook. Your bills tell your history. Every debt, every monthly payment, every dollar you owe is a claim against your future. Americans from all walks of life are carrying more debt. Kids still in college, married couples with kids, single men and women, rich people and poor people—debt is everywhere. And yet, when most people think about planning for retirement, debt is nowhere in the picture. (And when experts talk about retirement, many seem to assume that no one has any debt.) But the reality is that the over-50 crowd is carrying more debt than ever before in history. They have credit cards and car loans, and many are responsible for student loans they took on to help their

children through college. The average Social Security payment is about $12,000 a year—not even enough to live safely in many places, let alone comfortably—and certainly not enough to cover extra debt payments. And that debt is taking its toll: The elderly are now the fastest growing group in bankruptcy. Debt can be tough on anyone, but hitting your retirement years dragging along a pile of IOUs is a recipe for disaster. So how do you do it? Getting rid of your debt is a two-part process. The first part is to stop taking on new debt. This is the moment to look yourself in the mirror and say out loud: “No more debt.” If you are ready to get really serious, then it is time to give your credit cards a rest, and stop making new purchases for non-essential items. Once you have made the commitment not to take on any new debt, it is time to start tackling the old debt. We wish there were some magic secrets to quick and painless debt repayment, but there isn’t. Getting out of debt is basically just a matter of paying off your old bills, one at a time, until they’re gone. Start by adding up all your debts—the credit cards, doctor bills, past-due bills—everything down to the money you borrowed from your cousin. Include all your debts except your mortgage, student loans, and car loans. Write them down, whip out the calculator, and add them up. Then start paying them off, one at a time. Meanwhile, keep right on making your minimum monthly payments on the other debts. Once the first debt is paid off, pick another debt, and get that one paid off. Go through your debts one at a time until you are debt-free.