We all know we should be saving for retirement. The difficult part is motivating yourself to spend less now so you can build a nest egg for the future. Try these strategies to better prepare yourself for retirement in 2014.
Set up direct deposit to a retirement account. The simplest and most effective way to save for retirement is to set up direct deposit from your paycheck to a 401(k) or individual retirement account. "Use the new year as a chance to enroll in or to increase your contribution rate in your employer's 401(k) plan," says John Beshears, an assistant professor of business administration at Harvard Business School. "If your employer doesn't have a retirement plan, a similar principle applies to regular automatic transfers to an IRA or another account designed for asset accumulation."
Get an employer match. The fastest way to build a nest egg is to get some help from your employer. A worker who saves $2,000 for retirement and gets a 50 percent employer match on that amount will add an additional $1,000 to his nest egg. That's a better return on an investment than you are likely to get anywhere else.
Take advantage of retirement saving tax breaks. An employer match isn't the only perk of saving in a workplace retirement account. Your contribution to a traditional 401(k) or IRA is tax-deferred, meaning you won't have to pay income tax on your contributions until you withdraw the money. Low- and moderate-income savers may be able to additionally claim the saver's tax credit for their retirement account contributions.
Consider tax diversification. Roth 401(k)s and Roth IRAs allow you to prepay income tax on your retirement savings. These accounts can be particularly advantageous for people who are young or in low tax brackets because they can later withdraw the money tax-free. Roth IRAs are also useful to retirees because there's no big tax bill in retirement and annual distributions are not required.
Rebalance your portfolio. The value of your investments likely increased in 2013, so your current mix of assets is now quite different from your target asset allocation. Consider shifting your assets back to an allocation that is in line with your goals and risk tolerance. "It is also crucial that households revisit the investment options in their employer-sponsored retirement accounts and shift their allocations toward well-diversified options charging low investment expenses," says Clemens Sialm, an associate professor of finance for the McCombs School of Business at the University of Texas at Austin. "Households should first avoid investing in the stocks of their employers, and they should diversify their retirement accounts internationally and across different asset classes."
Simplify your investments. Few people dream of day trading or managing a complicated portfolio in retirement. "Simplify your accounts, especially retirement savings accounts," says Richard Kaplan, a law professor at the University of Illinois College of Law. "Consolidate, combine, whatever - get all accounts in one place to better coordinate investment strategy, more easily determine minimum required distributions, possibly defer such distributions if you are still working at a plan's sponsoring employer and generally ease the burden on your executor and other heirs."
Reduce your investment costs. It's difficult to control your investment returns, but you can control how much you pay in fees for your investments. "Households should eliminate high-expense investment options since these funds, on average, underperform low-expense funds," Sialm says. "Employees should also start to lobby their employers to improve the investment options available in 401(k) plans if their plans do not offer a sufficiently diversified menu of inexpensive investment options."
Make an investment checkup appointment. Set aside a block of time to check up on your retirement investments and make changes when necessary. "Many Americans procrastinate, meaning they have the tendency to delay costly action into the future instead of facing it today," says Colleen Flaherty Manchester, an assistant professor at the Carlson School of Management at the University of Minnesota. "If you know you have this tendency, you can counteract it by creating a commitment device, such as by scheduling time in your calendar to reassess your contributions and investment options, or making an appointment with HR."
Project your retirement income. One way to motivate yourself to save is to project what even a small amount of savings will grow to by the time you reach retirement. "A better understanding of compounding hopefully will show people the importance of starting early and also the value of contributing anything at any time and allowing it to compound over time," says Robert Clark, an economics professor for the Poole College of Management at North Carolina State University. "People tend not to think that $1,000 a year would grow as much as it could." Other research has found that picturing yourself in old age can also encourage people to save more.
[Read: Retirement Benefit Changes for 2014.]
Don't wait to save. Money you deposit in a retirement account will eventually be worth much more than the amount you contributed if you allow the account to accumulate for decades. "Due to compound growth (i.e., earning interest on your interest), contributions made early in one's career have the potential to generate large returns at retirement," Manchester says. "However, many Americans systematically underestimate compound growth and instead have the tendency to expect contributions to grow at a linear rate instead of exponential." Saving even a small sum for retirement, especially when combined with an employer match, tax break and compound interest, will put you on a path toward a more financially secure future.