If you’re like most people, you’ve probably thought a little bit about what your retirement will look like. It’s probably fair to say that you have dreams for retirement. Perhaps you want to trot the globe. Maybe you want to settle in a cozy cabin in the woods. It could be the Florida beaches. Or it might be something completely different. It might even be as simple as living where you’re living, simply with the freedom of not having to work.
Retirement Costs Money!
The problem is, retiring takes money. Depending on the kind of retirement you want, it can take a lot of money! But at the bare minimum, it takes enough to cover all your basic needs. Which, assuming your retirement lasts several years, is still a lot of money!
The retirement outlook for most Americans is depressingly dreary. Study after study find that the majority of working Americans have little stashed away in retirement plans. Some assume Social Security or a company pension plan (existent or not) will take care of their retirement. Others are convinced that they aren’t able to save. Some simply have no idea where to start saving, or how much.
(Almost) Everybody Needs to Save for Retirement
Unfortunately, most of the people who think they don’t need to save are wrong. You can’t count on Social Security. Even if it still exists when you retire, consider that a small supplement to your overall retirement plan.
Don’t plan on working until your dying breath. Even if you love your job, in all likelihood, health issues and aging in general will eventually keep you from working full-time. Regardless of your expectations for old age, it will be much easier to plan for the worst and end up with more than you need than running out of money when your earning potential is gone.
If you think your company has a pension plan set up for you, double-check with your HR department. Pension plans were standard practice for your parent’s generation, but they’re going the way of the dinosaur. This article by US News details the death of pension plans. If your company is one of the few that does have a pension plan, make sure you know the details. You don’t want to discover at your retirement party that the plan is much smaller than you expected.
How Much to Save
Everybody’s retirement needs are different. As a rough guideline financial advisers often recommend you contribute 15% of your paycheck if you start saving in your 20s. However, if you wait until your 30s and 40s, to retire, the amount you should be saving significantly increases, since the amount of time to build up your savings is lower.
Finding the Money to Save
Some people’s budgets are tighter than others, but if you look hard enough, you’ll likely find somewhere to eliminate some spending. You may have to make some hard choices such as eliminating a recurring expense that genuinely makes you happy. Perhaps you have to find somewhere to pick up some extra income. Other possibilities include downsizing to a smaller house or eliminating an extra vehicle. Just keep in mind that your future self will thank you for making these hard choices.
Where to Start
You want your retirement savings to be as tax efficient as possible, easy as possible, and profitable as possible. To keep your savings tax efficient, your best two options are the 401k offered by your employer (different from a pension), and an Individual Retirement Account (IRA).
Setting up a 401(k)
If your employer offers a 401k, this is the easiest option, although with more limited options. 401ks require almost no work to set up (typically signing a single paper). Contributions are automatically taken out of your paycheck, which protects you from ‘forgetting’ to contribute. As an added bonus, most employers will match a certain portion of your contributions. Do everything possible to at least get the full match. Otherwise you’re leaving free money on the table.
Setting up an IRA
If your employer does not offer a 401k, an IRA works great too. There are two kinds of IRAs- a Roth IRA and traditional IRA. In a Roth IRA, you invest with after-tax dollars. All retirement withdrawals from the Roth IRA are then tax-free. In a traditional IRA, your contributions are tax-deductible (meaning your contributions are essentially pre-tax). Then you pay tax on everything you withdraw in retirement. I prefer the Roth IRA to the traditional IRA. If tax rates and your income were both to stay the same between now and retirement, both kinds of IRAs would benefit you about equally. That’s a big if, however. I like knowing that with my Roth IRA, I don’t have to worry how tax rates will affect my retirement income.
You can set up an IRA with any number of brokerages. I strongly recommend Vanguard. Vanguard has low expenses, makes automatic investments easy, and has a great selection of funds. To maximize your earnings, pick investments with low costs (fees and expense ratios). And to keep things easy, put your contributions to the IRA on autopilot so you don’t have to think about it regularly.
What to Invest In
In both an IRA and a 401(k), you’ll need to pick investments. You also want to have a good balance between stock and bond funds in your retirement account. Stocks have historically outperformed bonds in the long-term, but are much more volatile in the short-term. When you’re a long ways off from retiring, think 20+ years, the majority of your mix should be in stocks. As you approach retirement, gradually move your investments into more bonds.
You also want to keep an eye on costs. With mutual funds, you don’t get what you pay for. In other words, higher fees and expenses do not translate into better returns. In your 401(k), your options are limited, so just pick the stock and bond funds with the lowest expense ratios. In an IRA, your options are virtually unlimited. Vanguard’s Total Market Stock Fund and their Total Market Bond Fund make great choices because of their ultra-low expenses and their wide diversification. An even easier option is Vanguard’s target date funds. With these, you simply pick the fund with the target date closest to your anticipated retirement fund. The fund auto-balances between stocks and bonds as you approach retirement.
You may be tempted to kick the can down the road. Don’t. The value of time is so crucial to building your retirement savings. Don’t put it off because you can’t save the recommended amount. Saving something is better than nothing and will make it much easier to catch up down the road. As you eliminate debt and other expenses, or increase your income, keep increasing your savings rate until you are where you should be.
And don’t be intimidated about opening an account. Even if you open an IRA on your own, mutual fund companies make it easy to set up and invest in an IRA. And if you’d rather, work with a financial adviser. The extra fee that financial advisers charge is better than not doing anything. Just don’t keep putting it off.
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.