If you’re reading this, good for you. It means that you’re at least willing to admit that you should get around to doing something about saving for retirement.
Ugh. I know.
There’s nothing fun about this. Saving hurts, for one. And retirement is, like, so far away that it’s easy to ignore.
But here’s the thing: Retirement is your eventual freedom from wage slavery — the necessity of working for food and shelter. Money you save for retirement is money that buys freedom to do whatever you want.
And even better: The sooner you start saving, the less you have to save to be able to stop working. Even $50 a month will make a difference.
Here are some other things to know about starting to save for retirement.
Retirement Saving Basics
1. Don’t be intimidated. All the numbers and acronyms are confusing, but this stuff isn’t as scary as it seems.
2. Start now (you’re never too young). A 22-year old earning $40,000 who starts putting 10 percent into a 401(k) and gets a three percent employer-matching contribution could have a nest egg of $1.7 million at age 65. And that’s not accounting for any raises or increased contributions over time. If you wait until you turn 32 to begin saving, however, the same contributions will only grow to about $780k. A fun goal is to try to save as much as you earn in a year before you turn 30.
3. Social Security won’t be enough. It’s a fact: Social Security benefit requirements will exceed contributions sometime around 2037. That’s long before most of us twentysomethings will retire. Chances are we’ll still see some kind of government-provided income when we retire, but it won’t be enough to live on. You must take charge of your own retirement!
4. The 401(k) is your friend. A 401(k) is a way to save for retirement through payroll deductions at work. The money you put in now is tax-free; you’ll pay taxes when you take the money out.
5. IRAs too. An IRA is an individual retirement account. You can start one of these anytime at almost any bank or investment company. A “traditional” IRA works like a 401(k) in that you can deduct the money you put in on your federal taxes, but will pay taxes when you take it out. A “Roth” IRA is the opposite; you don’t get a tax break for your contributions, but when you retire, all of your withdrawals are tax-free. (Hint: Roth IRAs are a great idea for young savers).
6. There are limits. The IRS sets the maximum amount you can contribute in tax-advantaged retirement accounts every year. In 2016, savers under 50 can put up to $18,000 in a 401(k). The IRA contribution limit is $5,500 for savers under 50.
7. But you can do both! If you contribute to a 401(k) plan at work, you can still open an IRA. That means in 2014, you can stash away up to $23,500 for retirement. A good strategy? Contribute to your 401(k) up to the maximum your employer matches, then max out a Roth IRA. If you have more to save, make more 401(k) contributions. And, if you have freelance or self-employment income, you may be able to save even more pre-tax money.
8. 401(k) contributions reduce your taxes! 401(k) contributions reduce your taxable income. If you’re in the 25 percent tax bracket and put $100 to your 401(k), you’ll save $25 in taxes. Your 401(k) account grows by the entire $100, but your paycheck only decreases $75.
9. 401(k) plans don’t have income limits. Although many tax-advantaged investments (including IRAs) have income limits, 401(k)s do not. That means that you can continue saving no matter how much you earn.
Matching and Vesting
10. Many employers “match” 401(k) contributions. If your employer has a 401(k) match program, they’ll help you save for retirement. The most common match is 50 percent up to a maximum employee contribution of six percent. That means if you save six percent of your annual salary, your employer will match half of it (three percent).
11. Not taking advantage of a match is like giving up “free money”. If somebody told you they’d put $5 into your savings account for every $10 you put in, you’d be stupid not to do it, right? That’s essentially what an employer match does, so if you don’t take advantage of it, you’re basically turning down “free” money!
12. Maximize your match. Many employers calculate their maximum match by calendar year (ask HR to be sure). That means if you haven’t been contributing to your 401(k) yet this year; you can contribute a much bigger amount for all the remaining pay periods to get more employer-matching funds.
13. Most employer-matched contributes are vested. This means that you have to work for your employer for a set number of years before all of that money is yours to keep. For example, if matched contributions are subject to a five-year vesting schedule, you’ll get to keep 20 percent of your employer’s matching contributions for every year you work there. All of the money appears on your 401(k) statement as soon as it’s invested, but if you leave early, the unvested amount will appear as a “forfeiture” when you withdraw or rollover your money. If you’re close to becoming fully-vested and are considering leaving your job, it might be wise to consider sticking it out a few more months.
Rollovers and Withdrawals
14. Don’t cash out! The government created retirement accounts with tax savings to encourage us to save for retirement,. That means if we withdraw the money before age 59 1/2, we’ll not only owe federal and state taxes on the amount we take out, but also a ten percent penalty. Ouch! So once the money’s invested, let it grow. Don’t withdraw it!
15. With IRAs, there are exceptions to the 10 percent penalty. There are very specific rules about IRA withdrawals. In most cases, if you withdraw your money before age 59 1/2, you must pay federal taxes and the 10 percent early-withdrawal penalties, but there are some exceptions. Two of note to younger savers: You may be able to withdraw money from an IRA penalty-free for qualifying higher education expenses and up to $10,000 to purchase your first home.
16. 401(k)s are tied to employers. When you leave a job, your 401(k) stays put until you decide what to do with it. The smart thing to do is to either roll it over to your new employer’s 401(k) or rollover to an IRA that you create anywhere you want. Simply ask your former employer’s HR person for the forms to initiate the rollover. You have some time, but don’t wait forever. Your employer or 401(k) may automatically give you cash dispersal if you don’t rollover your old 401(k) in a certain time period. This is especially true if you have a small balance. Unfortunately, you’ll pay taxes and that 10 percent penalty, so don’t let this happen!
Choosing Your Investments
17. Keep it simple. You don’t need to know much about investing to start saving for retirement. In fact, it’s best that you just ignore what the stock market is doing. The important thing is that you make the contributions. Most 401(k) plans offer what are called “target-date” mutual funds based upon the year you predict you’ll retire. These funds automatically adjust their investments over time; they start out aggressive and become more conservative as their target date approaches.
18. You can be aggressive while you’re young. If you won’t retire for 30 or 40 years, you can take big risks with your investments because you won’t need to access your money for a long time and you have plenty of time to take advantage of long-term growth. Allocate your investments in mostly domestic and international stocks.
19. Ask for help. Your employer can put you in touch with a representative from your 401(k) company who will be happy to help you choose investments at no charge. Take advantage of it.
20. Look for no-load mutual funds. If you open an IRA or rollover an old 401(k), you’ll have virtually unlimited investment choices. There are big differences in how much different funds charge, although determining mutual fund fees can be complicated. Look for no-load mutual funds, which will eat less of your returns.
21. Consider ETFs. Exchange-traded funds (ETFs) are a great simple way to invest and can be bought or sold anytime just like a singular stock. I’m a particular fan of index ETFs, which track entire markets with one fund. With ETFs, you can invest in the entire S&P 500, Dow Jones Industrial Average, and even commodity markets with just one investment.
22. Do some research. You don’t have to become a financial junkie, but the more you know about how investments work and which ones are best for you, the smarter decisions you can make. I use a free account with Morningstar to quickly research mutual funds.
23. Just do it! The most important thing is that you save for retirement. Something. Anything. Just start putting away today. Get help if you need it. Learn as you go. Just start saving!
- Get an IRA: Open an IRA online now