Here is what you need to know about retirement plans. SAVE! That is it; you just need to SAVE in them! It really comes down to that simple action.
Ok, in all seriousness, while I firmly believe the KEY to successful retirement planning merely is just to save there are a few more things you should understand. Here is what you need to know to build up your retirement savings, and it isn’t hard or confusing.
- SAVE SAVE and SAVE some more…I think you get the idea!
- Employer Plans
Understanding the plan you may have available through your employer will help you understand the benefits of the plan and why your employer is offering it, to begin with. The reason many employers offer a plan is primarily to attract and retain good employees, the owners want a savings vehicle, and the other is because the government gives them this way to provide you with a gift of extra savings!
These plans can go by different names, and that is primarily because they serve different types of organizations; 401(k), 457, 403(b) are a few well-known names. Generally speaking, an employer-sponsored retirement plan means that the company you work for set up an account just for you, so you can retire. Without it you could live in poverty when you, if you, retire. So, yes you should be thankful if your company offers a retirement plan, many do not! Your employer pays a lot of costs related to setting up the plan and maintaining it for YOUR benefit. Take advantage of it people!
When you save money into the account, set up just for you by your employer, the money is pre-tax, and it is automatically taken from your paycheck. You can elect to begin the savings any time you are eligible; some employers may require a 90+ day employment before you can start saving. The pre-tax amount doesn’t feel as big of a hit to your monthly income as it does when you save after tax. For example, let’s use a salary of $50,000 which after taxes my take-home pay is estimated to be $1,768 if I’m paid two times a month. If I decide to contribute $150 per paycheck pre-tax to my employer retirement plan, my new take-home pay is estimated to become $1,636. This means my take-home pay was only reduced by $132, not $150; that’s because the $150 isn’t taxed. You can use this calculator to see what will happen to your paycheck: https://smartasset.com/taxes/paycheck-calculator#E3TiGNrj1h
Beginning in 2018, you can save up to $18,500 per year in an employer-sponsored retirement plan or your salary amount if it is less than the $18,500. Your employer can contribute money to your account too! They call this a match. This is the best part! Besides this high contribution limit of $18,500, the free money from your employer is why you should never pass up saving in your company’s plan. The plan your company has will state how much the match is. It is commonly stated as a percent of your pay. For example, the company may state they will match your savings 100% up to 3% of your pay. So, if I contribute $150 per paycheck of my $50,000 salary, that is equal to 7.2%, if I’m paid in 24 pay periods. The company will also give me 3% or $62.50 each paycheck for my retirement account; that’s an additional $1,500 per year that I would have otherwise not received. Why would you pass that up? Now, not all employers choose to contribute to your account, but you should find out if yours does.
- Non-Employer Retirement Accounts
So what if you don’t have a company retirement plan? There are other accounts you can save in such as a Roth IRA or traditional IRA. The max you can contribute to these each year is $5,500 (combined contributions, you cannot save $5,500 into each account). Another savings account type is an individual or joint taxable account. There is no maximum savings rule for taxable accounts. All three of these account types allow for direct deposit savings, automatically from each paycheck. Not having an employer-sponsored retirement account is not an excuse for not saving for retirement. You must….SAVE!
For employer-sponsored retirement accounts, Roth IRAs, and Traditional IRAs your savings will grow tax-deferred, meaning you will not have to pay tax on the growth or income until you make a withdrawal in retirement, or after age 59 ½. If you take money out before age 59 ½, you will have to pay taxes plus a 10% tax penalty. Let’s make a few distinctions about the taxes for these accounts:
- Employer-sponsored accounts where you are contributing PRE-TAX money to your account, distributions after age 59 ½ will be taxed as ordinary income, like income from a paycheck.
- Employer-sponsored accounts where you are contributing AFTER-TAX money to your account, distributions after age 59 ½ are taxed only on growth/gains and income earned on the investments. Many employers offer an after-tax savings account, like a Roth 401(k) in addition to a traditional 401(k). This allows employees to contribute after-tax savings with a higher contribution limit than a Roth IRA outside of their company.
- Savings outside the company, into an IRA, is funded with money that has already been taxed through your paycheck. In this case, when you take money out after age 59 ½, you will only pay tax on gains and income. You can also deduct the savings amount from your taxes each year.
- Savings outside of the company, into a Roth IRA, with after-tax dollars, allows for ZERO taxes to be paid on gains or income when you take the money out after age 59 ½. Even if you are saving into a company plan, you should always consider saving into a Roth IRA every year. Let me say that again; there are ZERO taxes due when you take the money out in retirement!
- Individual or joint taxable accounts will pay taxes as you earn gains or income in the account, during the year which they are earned. There is no age rule for distributions; you can take the money out anytime. Be aware if you sell investments you will incur a gain or loss upon the sale.
Please see your accountant or visit the IRS website for more details on the taxes related to these accounts. There are income limits for contributing to some of them, and you want to understand which is best for you and your level of income.
- Selecting Investments
Company retirement plans and non-company retirement plans will offer available choices of investments for your accounts. Most company plans offer a list of mutual funds to choose from while individual accounts have a wider array of choices from individual stocks and bonds to also ETFs and mutual funds.
Remember to keep your investment choices diversified. If you are not going to be actively monitoring your account, you may want to avoid investing in individual stocks, but choose some mutual funds or ETFs instead. These baskets of stocks or bonds will give you a bit less risk exposure than owning just the one stock or bond alone. Own a variety of fund types; U.S. stock, foreign stock, short-term bonds, long-term bonds. The idea is to have a mix of investments that will perform differently in a variety of market environments. Start simple, don’t make this idea more complicated than it needs to be.
When selecting the right mutual fund or ETF you want to compare the performance to its peers and a market benchmark, to see if its historical performance has reached a target return that you are after. See our detailed list of how to select the right mutual fund here.
Review your investments at least once a year or during changing market environments. It is important to check your funds and make sure nothing has happened to the fund company or the returns of their fund. If they are underperforming and you have a better option, don’t be afraid to sell and replace it with a better choice.
Stop putting it off; it is time to save today! Get online and begin saving. For every raise, you should add more to your automatic savings. You can set up automatic savings for all types of accounts and some even let you auto increase your savings each year. The online tools, like savings calculators, are awesome out there. I do not know of a retirement plan or brokerage account that does not have these available. Start to play with them and set your goals. Know your budget and save as much as possible! You have to take charge of your future; no one will do it for you! Do it!
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