Question: How to save for retirement when starting in your 30s?

Are you ready for retirement?

I'm 33 and just started medical residency. I spent most of my 20's in school, so I don't have much at all saved for retirement or saved for anything really.

Now that I finally have a paycheck, I've figured that I can afford to save about 20 percent of it (or about $700 or so a month, so not a whole lot). Should all of that go directly towards retirement? Or should I save part of that amount for an emergency fund or potentially for a down payment for a house someday, and if so how much?

How do people manage to save for normal life events like houses, etc., while still being smart about retirement on this type of income? Thanks!

Response:

I like your 20 percent goal. I would put the maximum amount into your retirement savings plan at work (assuming your employer offers one).  The retirement contributions will likely average out to a savings rate of about 10 percent. This is money you won’t tap, even in an emergency. For example, if you pull money out of a 401(k) you’ll pay a 10 percent penalty plus your ordinary income tax rate on the withdrawal. Your employer might allow you to borrow from the plan, but that maneuver reduces the long-term return on retirement savings. (If your employer doesn’t offer one I would vote for a Roth-IRA for now. However, for 2013 the maximum you can put into a Roth-IRA is $5,500.) I would put your retirement savings into a low-cost, broadly diversified index funds.

The remaining 10 percent or so of savings should go toward building up an emergency fund. Despite ridiculously low rates on safe savings, I would park the cash in government insured savings accounts and U.S. Treasury bills. You can tap the money anytime you need it without penalty.

Here’s the thing: With disciplined savings your emergency fund turns into an opportunity fund, say, for a down payment on a home or to pay for an intriguing investment. Once you’ve built up enough savings to meet your basic expenses and needs for a year or so you can start investing any additional sums more aggressively. Think of the savings that’s a year’s worth of expenses as your “needs” pot. The savings above that sum is your “aspirational” pot. The money goes into a well-diversified low-cost portfolio owned in a taxable account.

You’ll pay taxes on dividends, realized capital gains, and interest payments along the way. You’ll fork over to Uncle Sam long-term capital gains when you cash in some or all of the portfolio -- assuming you’ve owned the investment for more than a year -- but it’s still at a lower rate than ordinary income tax rates. The big advantage of creating a long-term savings portfolio in taxable accounts is that it adds to your financial flexibility and your margin of safety.

Bottom line: A savings goal of 20 percent is terrific with about half in retirement savings and the remainder in taxable accounts.

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