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Investing Specialists

Dos and Don'ts for Late-Start Retirement Savers

Practical tips for making a save if you're getting serious about your retirement plan later in life.

Despite the helping hand of a strong market for five-plus years, plenty of workers are playing catch-up when it comes to their retirement savings. 

According to data from the National Institute on Retirement Security, two thirds of working households age 55-64 with at least one earner have retirement savings that are less than one times their annual income. Given the shrinking share of households covered by pensions, it's no wonder that 72% of people age 50-64 believe they will have to delay retirement, according to an AARP poll, and half don't think they will ever be able to retire.

Working longer is a win-win-win from a financial standpoint, but it may not be an option for some older workers. Rather, a combination of tactics--working longer (if you can), deferring Social Security (if you can), and continuing to save (again, if you can)--will give you the best shot at making retirement work if you're getting a late start on the savings component. 

If you count yourself among the late bloomers who are saving and investing for retirement, here are some tactics to consider, as well as some pitfalls to avoid. 

Do: Be prepared to take some risk.
The key attraction of cash and high-quality bonds is that they're less volatile than stocks. Whereas stocks lost more than a third of their value during the financial crisis, for example, such losses are unthinkable for bond investors. Meanwhile, investors in true cash instruments guarantee principal stability. 

But that peace of mind comes at the cost of lower returns: Bond yields have historically been a good predictor of the asset class' return over the subsequent decade, and they're right around 2% right now. Cash returns are even lower, making them a guaranteed loser when you factor in inflation. 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.
Yet, even as pre-retirees playing catch-up absolutely should emphasize stocks, it's 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, as well as allocate a reasonable share of their retirement portfolios to safer securities like bonds. In a worst-case scenario in which they needed to tap their retirement assets earlier than they expected, they could sell the safe stuff while leaving any stock assets intact. 

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 Jan. 1 of the year in which they turn 50; Vanguard research indicates that many savers miss out on catch-up contributions when they initially become available. 

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, aftertax 401(k)s, and spousal IRAs serve as additional receptacles for tax-sheltered retirement savings. 

And while investing inside of a taxable account doesn't provide you any shelter from year-to-year taxes on dividends and capital gains distributions, building nonretirement/taxable assets is also a worthy goal. Taxable accounts enjoy more favorable tax treatment on withdrawals than tax-deferred accounts like traditional IRAs and 401(k)s; you'll owe long-term capital gains tax on securities you've held more than one year, whereas you'll pay your ordinary income tax rate on anything you withdraw from a traditional tax-deferred account. Moreover, retirees can also benefit from tax diversification in retirement; maintaining assets in various account types can give them greater discretion over their tax bills each year. 

Do: Count on your own contributions, rather than market returns, to do the heavy lifting.
Stocks have returned 7% on an annualized basis in the past decade, and twice that much during the past five years. 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, more than 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. Minding such costs is a guaranteed way to improve your portfolio's take-home returns. 

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 aftertax 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. The best retirement calculators, such as the T. Rowe Price Retirement Income Calculator, factor in the role of taxes for you. But if you're calculating your retirement readiness on your own, be sure to give your portfolio a tax haircut.

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, thereby enlarging the benefit. Putting in even a few extra years, combined with some of the measures outlined above, can tip the scales of success in your favor. This article does a deeper dive into the financial benefits of working longer. Yet, working longer isn't always viable for a host of reasons, so this strategy is best used in conjunction with--rather than instead of--some of the saving and investing strategies discussed above. 

Don't: Assume that you'll necessarily be working in the same capacity.
When people hear that working longer is one of the best ways to make retirement finances work, they no doubt visualize slogging it out, full time, in their current industry, or even in their current position. But that needn't be the case. While your current career path may be the most remunerative, you may be able to find a pleasing middle ground later in life, working part time, on a consultative basis, or in a position that provides more personal gratification than your current career path. Morningstar contributor Mark Miller has written extensively about career paths for older workers; here's his latest dispatch.