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What are retirement savings & how can I start saving for retirement now?
Retirement savings is a fund of money that you create and contribute to while you're working. Over time you'll accumulate a nice amount, so once you retire you'll have enough money to pay your bills and maintain your lifestyle.
You can save for retirement in two ways:
1) On your own using an Individual Retirement Account (IRA)
a tax advantaged retirement savings account that you setup outside of your employer.
2) Through your employer if they offer retirement benefits.
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What are Contributions & Distributions?
The money you put into the account that accumulates throughout your working years are called your contributions.
When you retire you start receiving payments from your retirement savings, which are called distributions. Distributions are money withdrawals you can take from your retirement savings to replace paychecks once you retire.
Could I take a distribution before the age of 591/2?
You are allowed to take distributions before retirement age (59 1/2), but you'll face a big financial penalty. It's best to leave untouched until the required age.
How does my retirement grow?
Your money grows while it's in a retirement savings account because it's invested in the financial markets. Once you setup retirement savings account, you'll work with a bank or financial advisor to choose from various investment funds that hold stocks and bonds. However, some institutions are now offering crypto options but have limits on allocation. For example, your "fund" can only hold 5% of crypto. Your retirement fund could look like, 60% stocks, 35% bonds, 5% crypto. This means all of your contributions are invested in the market earning
Why is the market the best investment to grow your retirement savings?
If your money were in a basic savings account at a bank, it would grow less than 2% per year - but with your money invested in securities such as stocks and bonds it could grow by 7-12% per year, though this can vary as the market fluctuates through market cycles.
How Does Compounding Work?
If you're early in your career, retirement can feel like a long way off. So some people think they have more than enough time to save. However they are missing out on compounding interest. Because of compounding interest , the longer your money is saved, the more interest it earns, and the more your money grows and grows.
As an example, say your started with an initial contribution of $5,000 then add $500 each month at a return of 6%. If you start at age 25 and retire at age 65, you'll have almost $980,000 saved. However if you start when you're 30, you'll have about $707,000 saved.
How Does Retirement Help Me With Taxes?
Saving for retirement saves you on taxes in the immediate or short term, your savings grow tax free, meaning your dollar will go a lot farther.
You won't have to pay taxes on money you put towards retirement savings the same way that you pay taxes on income. And you'll wind up paying less income tax in the long run compared to other forms of saving.
What is the Difference Between a Traditional IRA & a Roth IRA?
There's two different types of tax options for your accounts; Traditional & Roth.
With a Roth IRA
You pay taxes when you contribute funds to the account, so you don't have to pay taxes when you begin withdrawing money down from the line.
Traditional IRA
These accounts are tax deferred, meaning you don't pay taxes on the money when you contribute to the account, but you pay taxes on the money when you withdraw it upon retirement
What is an example of an IRA contribution?
Let's say you earned $100 and you want to save that for retirement. If you contribute money to a Traditional account, you send money before paying taxes on it, so all $100 goes into your traditional account.
When you contribute to a Roth account, you're contributing after tax dollars. So you pay income tax on your $100. The exact amount depends on your income level and tax bracket, then the rest is sent to your IRA.
What is an example of a contribution?
A distribution is when money is sent from your account to you, it is distributed from your account.
In a Traditional IRA, if your balance is $100,000, you'll actually get less because you have to pay taxes when you withdraw the money.
In a Roth IRA, if your balance is $100,000, you'll get all $100,000 because you've already paid taxes on that money.
Contribution & Distribution Rules
Retirement accounts have contribution limits, meaning there's a max you can contribute each year.
Employer Sponsored Plan Limits: $22,500
IRA's: $6,500
There are also distribution rules:
No-Penalty Withdrawal: Age 59 1/2
How Do I Access My Retirement Account?
There are 2 main ways to gain access to a retirement account:
Through your job, with an employer sponsored plan
By setting up your own account with a brokerage Fidelity, TD Ameritrade, or your bank like CapitalOne or Chase. You will setup your own Individual Retirement Account.
Employer Sponsored Plan
Many employers offer a retirement savings plan as a benefit where they'll setup and manage the account for you. They often contribute to the savings on your behalf (did someone say free money? ) in the form of matching!
Deepening on what kind of company you work for, there are a few options employers may offer, the type of plan is determined by the type of job you have. You HR or Benefits department will have this information, it should also be included in your offer letter and associated materials.
401(k)
a retirement savings plan usually offered to private sector employees, where your individual contributions can be matched by an employer
401(a)
a retirement savings plan usually offered to government or non-profit employees
403(b)
a retirement saving plan offered to employees of non-profit companies
TSP
also called a Thrift Savings Plan, this is a retirement savings plan offered to federal civilian and uniformed service employees.
457 (b)
retirement savings plan offered to employees of state and local governments.
If you have a plan through your employer, you'll probably have less direct control over the investment options. Companies usually put together a few pre-packaged options that have different risk tolerance levels from which you can choose.
Investment options range from aggressive growth funds (which are riskier) to conservative income funds (which provide lower but more consistent returns. This is where knowing your risk tolerance comes into play
Risk Tolerance: your personal level of comfort with taking investment risks and potentially losing money. This may be influenced by your personality, investing goals, time horizon and more! Individual Retirement Account (IRA)
Anyone can open an IRA and begin contributing to their new fund. An IRA doesn't come with as many perks as an employer sponsored plan however. If you have access to both, experts advise maxing out your contribution to your employer account first before contributing to an IRA.
Company Match
Employer sponsored retirement savings is usually offered as benefit through your job. One thing that makes this perk so great is company matching.
Employers will match a percentage of your contributions up to a certain point of your salary. Sometimes, employers will match up to a certain dollar amount (regardless of your salary).
Match Rates
The exact amount your employer will match will vary company to company.
The exact amount your employer will match will vary company to company. 3will add $0.50 cents up to a certain percentage usually 6%. This basically means you can earn 3% of your salary in free money for retirement.
Match Example
If your salary is $50.000 and your employer offers a 6% match, you're making an extra $1,500 every year (as long as you contribute $3,000 annually)
Contribution is Key
Employer matching is a huge perk! Take advantage!
While maxing out your annual retirement savings account contribution (contributing $22,500) can definitely feel like a big reach, try to contribute at least enough to get the whole match.
Even if your employer doesn't offer a match, it's a good idea to contribute something to your employer sponsored plan every year.
How To Enroll
Like health insurance, you have to actively enroll in your employer sponsored account.
When you start your job, you should be given enrollment paperwork (either hard copy or electronic) from your HR department.
If you have the option to choose between Roth and Traditional, make sure to give it some thought and discuss with an advisor what would be best for your situation and select that option on the paperwork.
If you have the option of both you may be able to contribute to each one. Your contribution will be split between the two accounts.
Deciding What To Contribute
Once you sign up you now get to decide how much you'd like to contribute. You'll want to ensure this aligns with other financial priorities in your budget. Once you decide the amount you'd like to contribute , that amount will be taken from every paycheck.
Experts recommend that you put 20% of your monthly income towards savings. This includes retirement savings, emergency fund savings, and any other savings you are trying to build.
Contribution Goals
Many people recommend trying to max out your contribution, which means contributing $1,875 monthly to most employer sponsored accounts or about $540 monthly to an IRA.
If this isn't a realistic goal for you, at the very least, try to contribute enough to take full advantage of any employer sponsored match.
In a Fidelity report, research shows that the average person in their 20's contributes 7% of each paycheck to retirement and recommends that everyone try to get to the 10-15% range.
Asset Allocation & Risk Tolerance
When deciding what types of investments you want, there are a few main things to consider.
Your long term and short term goals
Your risk tolerance
Your investment preferences
Your answers to these questions will determine your asset allocation.
Asset Allocation: an investment concept that aims to balance your risk and return by dividing your money in certain percentages amount stocks, bonds, and other investments - this % breakdown should reflect your financial goals risk tolerance, and time horizon. Generally, the younger you are (which means the longer you have until retirement) the more time you have to rebound from any downs, so the higher tolerance for risk.
Watch Your Money Grow
Once enrolled, you should receive instructions on how to monitor your investments. Check in at least every few months to assess how things are performing. Remember your account balances will fluctuate due to the volatility of the market. Staying invested for the long term has historically resulted in an average of 7-12% return compounded annually.
If the market has a bad year or a few bad years, while everyone else is panicky, it is time to purchase, reassess your risk tolerance, and know that sticking with investing over the long term will result in great gains for yourself and your family.
Retirement Check Up Evaluation Checklist
1.) Log into your employer account
2.) Check on the amount you're sending per pay check (% and $ amount)
Are you able to contribute 1% more ?
Are you able to contribute $100 more?
3.) Check weather you're taking full advantage of any employer contribution, if not try to get the max amount you can out of your employer.
4.) Make adjustments to up your contributions in the future or schedule in your plan/calendar to do so when the time is appropriate.
5.) Check on your portfolio type to assess weather it matches your risk tolerance and asset allocation preferences.
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