Saving for retirement is especially difficult for workers with small salaries. Many low-income workers don't have access to a retirement account at work and simply have less money to build a nest egg after paying their monthly bills. Here are some strategies to save for the future on a small wage:
[See 9 Ways to Pay for Retirement.]
Set up a direct deposit. Have a portion of each paycheck automatically deposited into a 401(k), IRA, savings, or investment account. "Payroll deduction is one of the easiest ways for a worker to actually save," says David John, a senior research fellow for the Heritage Foundation. Start with as little as 1 percent of your pay and as you receive raises, direct a portion of each one into a retirement or investment account.
Take advantage of tax breaks. Saving in a retirement account has the added bonus of reducing your current or future taxes. Traditional 401(k)s and IRAs give you a tax break in the year you make the contribution, but income tax is due upon withdrawal. If you expect your income to grow significantly in the future, it can be smart to contribute after-tax dollars to a Roth 401(k) or Roth IRA. Roth accounts allow you to pay tax on your nest egg now while you are in a low-tax bracket, then withdrawals, including earnings, will be tax-free in retirement.
Claim the saver's credit. There is a tax credit specifically for low-income workers who save for retirement. If you contribute to a retirement account such as an IRA or 401(k) and your modified adjusted gross income is less than $28,250 ($56,500 for couples) in 2011, you may be able to claim the saver's credit. This credit is worth up to $1,000 for individuals and $2,000 for couples and can be used to reduce the federal income tax you pay, but is not refundable.
Redirect your tax refund and tax break. If you don't need your tax refund for immediate expenses or debts, consider saving a portion of it for retirement. Workers are also currently receiving a temporary 2 percent tax break on their Social Security payroll taxes in 2011. For someone who earns $30,000 annually, the tax break is worth $600. Consider directing that tax savings into a retirement account.
Minimize investment costs. The expenses and fees associated with an investment are deducted from your returns. "An IRA charges a fee to open the IRA, it charges annual fees, it charges closing fees if you decide to change jobs, it charges a trade commission if you trade. If you get a fund of funds, like a target-date fund, you are being charged for a management fee and then the underlying mutual fund fees," says Teresa Ghilarducci, director of the Schwartz Center for Economic Policy Analysis at the New School for Social Research. Avoiding as many of these fees as possible and choosing funds with low expense ratios will allow your nest egg to grow faster.
Delay retirement. Longer life spans mean even more years of retirement that need to be financed. Workers without traditional pensions may not be able to retire at the same age their parents stopped working. "Postponing retirement is an extremely powerful tool for those who are able to do it," says Mark Iwry, deputy assistant secretary for retirement and health policy at the U.S. Department of the Treasury. "You've got more years of earning. You've got fewer years of consuming as a retiree." Working longer doesn't mean you will need to work indefinitely. "People are living longer, healthier lives and fewer of them are working in physically demanding jobs," says Barbara Butrica, senior research associate at the Urban Institute. "Working an additional year, we found, raises retirement income by 9 percent overall and by 16 percent for low-wage workers."
Learn about Social Security. Social Security payments are the biggest source of retirement income for low-wage workers. "Social Security benefits are much more important to people with low income than private savings probably ever will be," says Butrica. The age when you decide to start your benefit can make a big difference in how much your monthly payments will be for the rest of your life. "Think carefully about whether you want to start that Social Security benefit right away when you hit 62, or whether it's really more valuable to you to wait until age 70 if you can do so," says Iwry. Monthly payouts increase for each year you delay claiming up until age 70.
Seek a job with good retirement benefits. Finding a job that offers a traditional pension, a significant 401(k) match, or a profit-sharing plan can significantly improve your retirement security. But only about half of the workforce has access to retirement benefits at work, and low-income workers are the least likely to have them. "About four in every ten 25- to 29-year-olds who are working are working in jobs that don't offer retirement plans," says Margery Austin Turner, vice president for research at the Urban Institute. "Low-income workers aren't accumulating the assets they are going to need for a secure retirement." When an employer contributes to a retirement plan, you can build a significant nest egg faster.
Don't spend your savings early. Once you begin to build a nest egg, try not to spend any of it before retirement. "Many of the withdrawals from 401(k)s and IRAs were associated with job loss and disability and investment sorts of things, like home purchases," says Butrica. For these types of emergencies you can sometimes tap your IRA savings early without being hit with the typical 10 percent early withdrawal penalty. But early withdrawals also mean that you won't have that money and the valuable compound interest it could have generated in retirement. "I think we need to encourage people to avoid unnecessarily dipping into their savings before retirement," says Butrica. "Workers must consistently make large contributions to their accounts to accumulate significant savings. This is going to be very difficult for low-wage workers to do."