by Emily Brandon
Saving for retirement is especially difficult when you are earning a small salary. However, there are a variety of ways you can begin building a nest egg, even if you are receiving small paychecks. Here are some strategies to invest for retirement with a low income:
Claim tax breaks for retirement saving. Saving for retirement in a 401(k) or individual retirement account allows you to reduce your tax bill. A worker in the 15 percent tax bracket who contributes $500 to a traditional IRA will save $75 in federal income taxes. The same contribution made by someone in the 25 percent tax bracket would reduce the tax bill by $125. IRA contributions can be made up until your tax filing deadline, so it’s worth plugging an IRA contribution into your tax-planning software to see how much your tax bill will decline if you can come up with the cash for an IRA deposit.
In addition to this tax deduction, workers with incomes of up to $30,000 for individuals, $45,000 for heads of household and $60,000 for couples in 2014 can claim the saver’s credit. The credit is worth 50 percent, 20 percent or 10 percent of your retirement account contributions, up to $2,000 for individuals and $4,000 for couples, with the largest credit going to workers with the lowest adjusted gross incomes.
Consider a Roth account. After-tax Roth accounts don’t give you a tax deduction in the year you make the contribution, but you will not have to pay taxes on withdrawals from the account in retirement. Roth IRAs and 401(k)s can be especially beneficial to people with low earnings because they pay a low tax rate on their contributions. For example, a worker in the 15 percent tax bracket who expects to get a higher-paying job that results in him jumping into the 25 percent tax bracket later in his career and in retirement would be better off making Roth contributions and paying taxes on that income now while his tax rate is low. That way, he will pay the 15 percent tax rate on the money now instead of the 25 percent tax rate when he takes the money out in retirement. “The benefits of a Roth are great in the long term,” says Teri Alexander, a certified financial planner and president of Alexander Financial Planning in Columbus, Ohio. “As long as the money is in a Roth for five years or until you turn 59½, whichever is greater, you can take money out after that point totally tax-free, and once you turn 70½, you are not required to take that money out at that point in time as you are with an employer plan or regular IRA.” Additionally, Roth contributions make you eligible for the saver’s tax credit.
Seek a job with retirement benefits. The fastest way to grow your nest egg is to find an employer that will make contributions to your retirement account. A 401(k) match and other types of employer retirement account contributions are part of the compensation package that should be considered when comparing job offers. If you do get a 401(k) match, make sure you contribute enough to get as much of it as you can. “If your company matches up to 4 percent and you are not putting in that 4 percent, you are essentially turning down extra money,” says Steven Bové, a certified financial planner and president of Lebrigh Life Planners in Oldsmar, Florida.
Make saving automatic. A major perk of 401(k) plans is having the money withheld from your paycheck before it ever hits your checking account and is available for spending. If you don’t have a 401(k) at work, you can create this effect by having part of every paycheck directly deposited into an IRA. “If you take $50 or $100 out of each paycheck and that starts happening automatically, it’s not something you have to think about every time you get each paycheck,” Alexander says. “When it’s something that happens automatically, you don’t miss it.”
Watch out for fees. The fees you pay to invest result in lower returns and slower investment growth. Take the time to shop around for investments with reasonable or low fees. “Fees matter because any fee that you pay is coming out of the return that you are getting,” says Gwen Gepfert, a certified financial planner and principal of Oaktree Financial Planning in Basking Ridge, New Jersey. “Individuals are best served having a passive investment approach and buying very low-cost index funds.”
Save raises and windfalls. Aim to save at least a portion of every raise, bonus, tax refund or other cash windfall. “If you happen to be lucky and get a bonus, take 10 percent of your bonus and do something fun with it, but take 90 percent of your bonus and save it,” Gepfert says. “The same thing goes with a tax refund. Don’t use that as a reason to spend money just because you got a large check.”