As most workers are responsible for their own retirement savings these days, high schools don’t have essential classes on 401(k)’s and Individual Retirement Accounts (I.R.A.s). And colleges generally don’t teach anything about Roth I.R.A.s or 403(b)’s. That’s where we come in.
Here is what you require to know about saving for life after you stop working and getting on the path toward a comfortable retirement, no matter your career or the size of your pay check.
- 1 Start Early
- 2 Understanding Your Investment Account Options
- 3 How to Invest Your Money
- 4 Fees
- 5 Routine Financial Tuneups
- 6 Getting Your Money When You Need It
1. The magic of compound interest. You’ve possibly read about this before, but the best way to understand it is to see it in front of you.
Yes, we did that math rightly. If two people put the same amount of money away each year ($5,000), earn the similar return on their investments (6 percent annually) and stop saving upon retirement at the same age (67), one will end up with almost twice as much money just by starting at 22 instead of 32. Put another way: The investor who started saving 10 years previously would have about $500,000 more at retirement. It’s that simple.
2. Saving is a habit. It may make rational, mathematical sense to start saving early, but it isn’t constantly easy. But the instinct to save grows as you do it. It’ll start to feel good as you observe that account balance grow.
How much should you save?
The short answer: As much as you sensibly can?. Sure, you’ll see articles telling you to save as a minimum 15 percent of your income; that’s a fine benchmark, though the true number will depend on how long you hope to work, what kind of legacy you may get and a bunch of other unknowable facts. So start with something, even if it’s just $25 per paycheck. Then, attempt to save a little bit more each year. Do it early and often enough so that saving becomes second nature.
Understanding Your Investment Account Options
At present that you’ve made the right choice in deciding to save for retirement, make sure you are investing that money wisely.
The line-up of retirement accounts is a giant bowl of alphabet soup: 401(k)’s, 403(b)’s, 457s, I.R.A.s, Roth I.R.A.s, Solo 401(k)’s and all the rest. They came into existence over the decades for particular reasons, designed to help people who couldn’t get all the benefits of the other accounts. But the result is a method that leaves many confused.
The first thing you need to discern is that your account options will depend in large part on where and how you work.
If you work at a for-profit employer
Available account: 401(k) plan.
Rider your for-profit employer offers any workplace retirement savings plan, it’s probably a 401(k). (Many smaller employers do not.) You can usually sign up for this any time (not just throughout your first week on the job or during specific periods each year). All you have to do is fill out a form saying what percentage of your pay check you want to save, and your employer will deposit that amount through a company (like Fidelity or Vanguard) that will grasp it for you. Here, automation is your friend. Some employers will repeatedly raise your savings rate each year, if you let them. And you should.
Things to Know About a 401(k)
Matching: If you’re really fortunate your employer will match some of your savings. It may match the whole lot you save, up to 3 percent of your salary. Or it may put in 50 cents for each dollar you save, up to 6 percent of your salary. Whatever the offer is, do whatever you can to acquire all of that free money. It’s like getting an instant raise, one that will pay you still more over time thanks to the compound interest we were talking about before.
Caps: How much can you put sideways in a 401(k)? The federal government makes the call on this, and it regularly goes up a bit each year.
Taxes: since with most other employer-based plans, when you save in a 401(k) you don’t pay income taxes on the money you set to the side, though you’ll have to pay taxes when you eventually take out the money.
If you work at a non-profit employer
Available accounts: 401(k), 403(b) and 457 plans.
If you work for the government or for a non-profit institution like a school, religious organization or a charity, you probably have different options.
What to Know about a 457 plan: These are a lot like 401(k)’s, so read the section above to appreciate them better.
What to Know About a 403(b) plan: These frequently show up at nonprofits — 401(k)’s are rarer here — and often get complicated and expensive. You may be encouraged (or forced) to put your money into an annuity in place of a mutual fund, which is what 401(k) plans invest in. (More on mutual funds later.) Annuities strictly are insurance products, and they are very tricky even for professionals to decipher. Which brings us to the expensive part: They often have very high fees.
In some instances, particularly if your employer is not matching your contribution, you may want to skip using 403(b)’s in total and instead use the I.R.A.s we discuss below.
If your employer offers no plan or you’re self employed
Available accounts: I.R.A., Roth I.R.A., S.E.P. and Solo 401(k) plans.
People who are setting up their personal retirement accounts will usually be dealing with I.R.A.s, obtainable at financial-services firms like big banks and brokerages.
What to Know About I.R.A.s:
Choosing where to start an I.R.A.: Ask the financial institution for a entire table of fees to see how they compare. How high is the cost to buy and sell your investments? Are there monthly account preservation fees if your balance is too low?
In general, what you invest in tends to have far more contact on your long-term earnings than where you store the money, as most of these firms have pretty competitive account fees nowadays.
Caps: As with 401(k)’s, there may be limits to the quantity you can deposit in an I.R.A. each year, and the annual cap may rely on your income and other circumstances. The federal government will adjust the limits every year or two.
Taxes: Perhaps the biggest dissimilarity between I.R.A.s has to do with taxes. Depending on your income, you may be capable to get a tax deduction for your contributions to a basic I.R.A. up to a certain dollar amount each year. Once more check the up-to-date government information on income and deposit limits and enquire the firm where you’ve opened the I.R.A. for help. After you hit the tax-deductible limit, you may be capable to put money into an I.R.A. but you won’t get any tax deduction. As with 401(k)’s, you’ll pay taxes on the money formerly you withdraw it in retirement.
What to Know About Roth I.R.A.s:
The Roth I.R.A. is a breed of I.R.A. that behaves a bit differently. With the Roth, you pay taxes on the money previous to you deposit it, so there’s no tax deduction involved upfront. But once you do that, you certainly not pay taxes again as long as you follow the normal withdrawal rules. Roth I.R.A.s is an especially good deal for younger people with lower incomes, who don’t pay a lot of income taxes now. The federal government has strict income restrictions on these kinds of everyday contributions to a Roth.
What Are S.E.P.s and Solo 401(k)s?
One more variation on the I.R.A is a S.E.P. (which is short for Simplified Employee Pension), and there is also a Solo 401(k) choice for the self-employed. They came with their own set of rules that may permit you to save more than you could with a normal I.R.A.
What happens if you change jobs?
When you leave an employer, you may decide to move your money out of your old 401(k) or 403(b) and combine it with other savings from other earlier jobs. If that’s the case, you’ll normally do something called “rolling the money over” into an I.R.A. Brokerage firms offer a diversity of tools to help you do that, and you can read more about the process here.
That said, some employers will try to talk you into leave-taking your old account under their care, while new employers may try to obtain you to roll your old account into their plan. Why do they do this? Because the further money they have in their accounts, the less they have to disburse in fees to run the program for all employees.
But leaving your money behind or rolling it into your fresh employer’s plan may have disadvantages. Most employer plans may have only a restricted menu of investments, but your I.R.A. provider will generally let you invest in whatever inexpensive index funds you want.
Also, it’s commonly best to keep all of your retirement money in one place; it’s easier to stay track of it that way. So, revolve all your retirement accounts into an I.R.A. once you leave a company to shorten things, especially as you near retirement. You can’t count on former employers to communicate as your home or email addresses change. Nor will every entity that has an account in your name necessarily track you down when you close to retirement.
How to Invest Your Money
You don’t need to be financially savvy to make elegant investment decisions.
Don’t get fancy
Dozens of books exist on the right way to invest. Tens of thousands of people use their careers suggesting that they have the best formula. So let us try to cut to the chase with a easy formula that should help you do just fine as long as you save enough.
Think humble, boring, simple and cheap.
Humility comes first. Yes, there are people who can choose stocks or mutual funds (which are collections of stocks, bonds or both) that will do better than anyone else’s picks. But it’s unfeasible to predict who they will be or whether the people who have done it in the past will do it again. And you, researching stocks or industries or national economies, are improbable to outwit the markets on your own, part-time.
The boring glory of index funds
Your best bet is to purchase something called an index fund and keep it forever. Index funds buy every stock or bond in an exacting category or market. The advantage is that you know you’ll be capturing all of the profits available in, say, big American stocks or bonds in emerging markets.
And yes, buying index funds is boring: You generally won’t see enormous day-to-day swings in prices the same way you may if you owned Apple stock. But those big swings come with influential feelings of greed, fear and regret, and those feelings may reason you to buy or sell your investments at the worst possible time. So best to evade the emotional tumult by touching your investments as little as possible.
How to choose index funds
How much of each kind of index finance should you have? They come in dissimilar flavours. Some try to buy every stock in the United States, large or small, so that you have contact to the entire American stock market in one package. Others try to buy every bond a company issues in a finicky country. Some investment companies sell something called an exchange-traded fund (E.T.F.), which are index resources that are easier to trade. Either flavor is fine, since you won’t be buying or selling the funds much anyhow.
As to your own allocation between, say, stock funds and bond funds, much will rely on your age and how much risk you’re comfortable taking. Stock funds, for example tend to bounce around more than bond funds, and stocks in certain emerging markets tend to bounce around more than an index support that owns, say, the stock of every big company in the United States (or everyone on earth).
Get Help: Most employer-based plans, like 401(k)’s and still plenty of 403(b)’s, contain target-date mutual funds. These are baskets of funds that may hold some combination of stocks and bonds from different size companies from all over the world. You can decide one of these funds based on the year you hope to retire — the goal year will be in the name of the fund. Thus, if you’re 40 years from retirement, you’d pick a fund with the year in the name that is closest to 40 years from now. After that, the fund slowly changes the mix of funds over time so it gets a bit less risky with each year, since you get closer to the period when you’ll need the money.
No Help Available? If you’re on your own, one alternative is to pick a single target-date fund made up entirely of index funds and presently shovel all of your retirement savings into that. That way, you have all of your savings portioned into an suitable mix that the fund manager will adjust as you get older (and presumably less liberal of risky stocks).
Some companies called rob advisers offer a different service. These robots will first enquire you a series of questions to gauge your goals and risk tolerance. After that, they’ll custom-craft a portfolio of cheap, indexed investments.
Nothing in life is free, yet when it comes to saving for retirement.
Retirement accounts are not free, and the charge you pay eat into your returns, which can cost you plenty come retirement. If you are working, the company that runs your plan (and whose name appears on the account statements) is charging your employer charge for the service. Plus each individual mutual fund in the plan has its own costs. If you are self-employed, you’ll be charged for your I.R.A. at the joint fund level and then pay whatever fees (if any) that the brokerage firm levies on an annual basis or for every trade you make in your account.
Yet another reason to pick index funds: Index funds tend to be the cheapest investments accessible, in addition to doing quite well over time when compared to other funds run by people trying to outperform everybody else’s market predictions. So investing in index funds is like winning twice.
Rider you want to learn more about identifying and deciphering retirement account fees, start with this progression of stories. But because most of us don’t have much context for what is sensible, employees of large organizations should turn to Bright scope for its rankings of thousands of employer-based plans.
If you’re saving on your personal and are curious about a particular target-date mutual fund and its fees, you can verify its ranking on Morningstar and compare it to other funds. As for those rob advisers, the money they’ll put you in are usually quite cheap. You’ll regularly pay another quarter of a percentage point of your balance each year in exchange for their support in putting your portfolio together and custody the investments in their proper proportions.
You can completely save that money by handling those trades on your own. But the question you have to ask yourself is whether you’ll have the regulation to continue doing it year after year after year. If not, then that fee might appear like a reasonable price to pay for the help (and for keeping you from making bad trades).
Fee too high?
Don’t like how high your fees are? You can attempt to lobby for better 401(k) or 403(b) plans.
Routine Financial Tuneups
Once you set them up, it just takes a few minutes a year to keep tabs on your retirement accounts.
Following setting up automatic savings from your pay check, it’s easy to forget about it. (And if you do, that’s O.K. You’ll likely be pleasantly astonished when you do check in on your funds in a few years.) But, if you can spare an hour each year to check in on your accounts, you can ensure that you’re doing the best you can with your well-deserved money.
1. Save 1 Percentage Point More from Your Paycheck
Time required: 5 minutes
If you followed our previous advice, you set it up so you have money automatically taken out of each pay check for your retirement account. You hardly miss it, right? So increasing your savings by another percentage point possibly won’t hurt your budget much. Over time, it could add up to six figures in additional savings.
2. Reconsider Your Investments
Time required: 30 minutes
Are you saving excessively for a down payment or children’s college tuition but not enough for retirement? The home may be able to stay, and it’s easier to borrow money for a child’s education than it is to get loans to pay for your retirement expenses. Make sure you are investing intelligently, for the most important things.
3. Rebalance Your Investments
Time required: 30 minutes
It’s been a grand half decade for stocks. So if you set up accounts five years ago with the intention of having 70 percent of your money in stocks, the growth in those stocks may mean that your investments are currently in a stock allocation that’s many percentage points higher. If so, it’s time to sell some stock and purchase, say, more bond mutual funds to put things back into balance.
Getting Your Money When You Need It
For a 401(k) plan: It’s likely to get access to your money before you retire. Most 401(k) plans offer loans, where you can use from your investments.
The good news: If you receive a loan from a 401(k) plan, you pay interest to yourself.
The bad news: You may omit on market gains during the repayment period. If you leave an employer before you’ve paid off the loan, you have to repay in full speedily, lest the loan turn immediately into an official withdrawal.
If you want to take out money from a 401(k) plan permanently before the legal retirement age, it may be likely depending on your plan. Such withdrawals are generally known as hardships.
For an I.R.A.: With I.R.A.s, you have to start taking a convinced amount of money out each year once you turn 70½. That’s the government’s way of forcing you into converting that money into profits that it can tax, even if you don’t need the money right away. Roth I.R.A.s, still, are not subject to the same withdrawal rules. If you’re under 70, the early withdrawal rules need taxes and penalties, just as they do with a 401(k). But you can take some money out of some accounts for confident special occasion purposes, like buying a first-time home or paying college tuition.
Once you’re retired
Once you’re totally retired, how much can and should you take out each year? For numerous years, financial professionals figured that if you took out no more than 4 percent of your savings every year starting at age 65 or so, you stood a very good chance of outliving your money. Except so much depends on the nature of your investments, your age, your health, your spending and aid goals and a host of other things. Given that, following a universal rule of thumb could be unsafe.
That’s why talking to a financial professional about your whole financial life as you approach retirement is probably a good idea. Make sure to converse to someone who agrees to act as a fiduciary, which means they vow to work in your best interest. If you’re not seeking a long term relationship, find a financial planner who is prepared to work by the hour or on a flat-fee project basis.
Before you pay anyone for financial help, though, do some careful work (with your partner, if relevant).
- What do you value the majority in life?
- How can spending and giving hold up those values?
- How much is sufficient when it comes to housing, travel and leisure?
- How much is too much?
Better yet, start judgment about those questions decades before retirement. The sooner you start, the calmer you’ll probably be about the money you do save and the more firm you’ll be about putting enough aside to meet all your lifelong goals.
We’ve tackled some of the most ordinary questions about retirement saving.
What about social security?
Chances are, Social Security will still be approximately once you hit the eligibility age, but it possibly won’t provide enough money, after taxes, for all the expenses you’ll face in retirement. Plus, it’s likely that some of the rules will change before it’s your turn to save.
In general, if you can, you should wait till age 70 to take your Social Security money, since the monthly checks will be bigger at that point. Thus there may be a gap you need to bridge if you want or need to retire before you turn 70.
If there are two adults in the family who together work, should they both be saving for retirement?
Yes. Two of the biggest potential charge in retirement is health care and long-term care, like paying for a nursing home. You both may require above-average amounts of treatment and assistance, so more savings will mean more option later on (and more tax breaks at present if you do save).
How do I know if I’m saving enough?
You can’t, actually. It’s hard to know how long you’ll want to work, how long you’ll be physically capable to work, how long an employer or customers will be willing to let you work for them, how much money you’ll essentially want to spend once you retire, and how long you’ll live when you’re done working. And you can’t predict your investment returns.
Given all the variables, you may be tempted to heave your hands and put off the decision to start saving or to increase your savings. Please don’t. If the potential feel overwhelming, just save as much as you reasonably can, as our Sketch Guy columnist, Carl Richards, puts it. Over, more savings now will mean more and better options later.
This is hard. How do I find an advisor who can help?
The standard advice is to chat to someone you trust and see that they use and like. But a lot of smart people know very little about money and have no idea if a financial adviser is treating them badly.
First find a few advisers to interview. Two fine places to start are the National Association of Personal Financial Advisors (Napfa) and the other is Garrett Planning Network. Members of both organizations lean to be transparent about their fees. Definite, there are some bad seeds in these two groups (as there are everywhere), and there are plenty of grand advisers who work for more traditional brokerage firms (those are not members of the two groups). But your odds of speedily finding someone good will be high in these two organizations.
There are some other hints that can assist you finding a good adviser. Check their certifications. If an adviser is a certified financial planner (C.F.P.) or chartered financial analyst (C.F.A.), that resources that he or she has learned a lot along the way and passed some difficult exams to earn those initials. (Other titles and acronyms may mean greatly less.)
Then set up an initial meeting with a few advisers. Ask each if he or she pledges to perform in your best interest, always. The fancy term for this is acting as a “fiduciary,” and by all means asks your adviser to take the fiduciary pledge we produced a few years back.
Then, ask a potential adviser questions about the charge you’ll be paying — to the adviser, for your investments and anything else.
Finally, balance your notes about each adviser you spoke to. Be real about how real you’re going to require getting with this stranger. So much of these money conversations are about feelings: our fears, our goals and our strongest values expressed during our spending, saving and giving. Does this person care about your feelings? Are the people you’re talking to still asking about them? If not, keep looking.