Ask the Blogger: How Can I Make Up for Lost Time on Retirement Savings?

I'm 47 and have a thin 401(k). What do I do now?

Dear Blogger:

What advice do you have for me as a late-stage retirement planner? I'm a 47-year-old single man in career transition, formerly in publishing but now working various contract assignments that cover my expenses (including medical benes) and usually leave enough to set a small amount aside. I am single with no children or property, I own my car, I'm carrying about $10K on credit cards, my savings, after nine months of working two jobs, amount to one year's current expenses (in Los Angeles), and I have a poorly tended 401K with maybe another $10K in it. What's the most effective way for me to build towards retirement?

Late Boomer

Dear LB:

One of the most valuable pieces of advice I ever received came from the instructor of a driving class I had to take in order to get my driver's license at the advanced age of 23. This one piece of advice, offered by a grizzled man who regarded it as his grim duty to regale us with grisly accident stories, has kept me from ever incurring a moving violation, much less getting into a serious accident. His advice?

"If you start late, you're going to get there late."

There is no way to make up lost time; those moments are gone. And people who have delayed saving for retirement, like people who have left the house twenty minutes later than they should have, are often tempted to take big risks. As you can see by turning on the news any night, this is a bad idea in the case of automobiles. It's not much better when you're talking about retirement savings. So alas, I do not have any magic investment vehicle which will painlessly replicate the effect of saving for 20 years--if such a thing existed, then we'd all wait until our late forties to save.

As someone who lost prime years of retirement savings to unemployment and excessive student loan debt, I feel your pain. I also have a message of hope: it's not too late. Now that I've severely bummed you out, the good news is that you still have time to do the right stuff. It's just going to be a little more challenging than it would have if you'd started earlier.

You're already doing a lot of stuff right. You have insurance to protect you from the financial hit of medical bills. (I'd like to see you add at least a modest disability policy if you can get one written on your freelance income.) You've got a healthy emergency fund. And you are saving every month.

With a lot of people, the first step is "Hey, stop spending more than you make!" You're doing well even in a challenging work situation. Here's how to do even better: pay off that credit card debt. Make that your top priority. If you had a full-time job, or a longer contracting history, I'd urge you to dip in the emergency fund, but in your situation, it probably makes sense to leave it alone; freelance cash flows are notoriously variable.

But now that you have that emergency fund, you need to get rid of that debt. Even if you have a low interest rate, you're probably sending the credit card company 1% of the balance every month in interest. Paying it off will give you a guaranteed double-digit return. Don't touch that 401(k)--the penalties are too high. But don't do anything else until you've paid off that debt.

Once you've gotten it cleared out, it's time to open up a tax-advantaged retirement savings account. Start with an IRA, which will allow you to put away $5,000 a year up to age 50, and $6,000 a year after that. Max out those contributions. If you have maxed out your IRA, and still have more room to save, look into opening an SEP, which can only be paid for using self-employment income. You can save up to 25% of your W-2 income, or $50,000--whichever is lower.

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Overall, because you're a late starter, I'd say you should be targeting an aggressive 20-25% of income as savings every year. (Pauses to let the anguished screaming die down.) Right now, this may be difficult. But as the economy improves, and you have more experience as a contractor, you should see your income improving. Try to save most of the extra income until you're at a comfortable savings rate.

As a graduate of the University of Chicago's Business School, home of the efficient markets hypothesis, I advise putting those savings into broad stock index funds. You will not be able to "make up" lost time by gambling on a high-risk, high-reward proposition. But you also won't be able to lose it all on high management fees and dubious investment decisions.

You should also be planning on working until 70 if you possibly can. Doing so will ratchet up your social security benefit, and also, give you more time to save. It's not always possible, but do everything you can to make it possible by keeping skills updated and actively managing your business/career.

There are two lessons here: first, if you don't save for retirement early, you have to sacrifice more consumption later. The magic of compound interest means that it's always hard to make up for lost time.

But the second lesson is: don't panic. First of all, there's no point, because panicking is not actually going to make your retirement accounts grow faster. But second of all, there is always hope short of the grave. Colonel Sanders founded Kentucky Fried Chicken at the age of 65. "More difficult" is not the same as "impossible".

Barring tragic accident, LB, you have at least twenty good years to pack away the savings and set yourself up for a comfortable retirement. And if you have a tragic accident, look on the bright side: you won't have to worry about retirement any more!

But since we all hope that you remain alive and well for decades to come, let's focus on boosting those IRAs, and planning to work a bit longer than most of your counterparts. As long as you make a real committment to savings, and don't try to go to fast, you can live decently now and still make sure you can also live decently in your golden years. You may get there a little late. But you and your checking account will be in one piece.