How to Start Your Retirement Strategy Off on the Right Foot
With all the dire “retirement crisis” stories and statistics out there, most young professionals today are aware of how important it is to save for their own nest eggs – no matter how far away their own retirement may seem.
However, knowing it’s important doesn’t necessarily make it any easie/personal-loans/r to do. Is it as simple as allocating money to your 401(k)? If so, how much, and how do you reconcile that with other expenses like student loan bills (which most young professionals are dealing with today)? And what if your employer doesn’t offer a savings plan?
Chances are, some of these questions have crossed your mind more than a few times – but between building a career and managing a busy personal life, you may have filed them away under “stuff to figure out later.” However, the sooner you get this worked out, the more time your savings and investments will have to grow and compound, improving your retirement situation by leaps and bounds.
So why not take a few minutes right now to figure out how to put your retirement strategy on the right track? Here are a few common questions and answers to get you started.
Okay, so let’s start with where I’m putting this money – how do I choose the retirement account that’s right for me?
There are a few main types of tax-advantaged retirement plans: the employee sponsored 401(k) or 403(b), the traditional IRA and the Roth IRA.
If your employer offers a 401(k) (the most common option) or 403(b) plan (for employees of public schools and tax-exempt organizations), this is usually your best bet. Your contributions come right out of your paycheck before they’re even taxed – and before you have a chance to miss them. Most companies will even match up to a certain amount. Once your account is funded, you’ll typically be able to choose from a menu of mutual funds and/or exchange-traded funds (ETFs), and your investments will grow tax-deferred until you withdraw funds from the account at retirement. Withdrawing funds prior to retirement (which at this point is considered age 59 ½) usually results in a hefty penalty, so try to leave it be until later in life.
If your company doesn’t offer a plan, your next option is to open your own traditional or Roth IRA. Traditional IRA contributions are not taxed on the way in, but proceeds are taxed on the way out. Roth IRAs are the opposite – contributions are taxed on the way in but not on the way out, which means the upside potential is pretty significant (considering you’ll likely be in a higher tax bracket later in life). However, Roths are only available to people whose income is below a certain amount (in 2014, $114,000 for singles and $181,000 for married people filing jointly – check with your tax advisor for current eligibility requirements).
Exactly how much should I be contributing to my plan each month?
You could start by working backwards from how much money you think you’ll need in retirement, but if you’re just starting out, this approach can be overwhelming. With people working and living longer these days, that magic number can be a bit of a moving target. At this point, the most important thing is usually just to save something – you can worry about specific goals and ramp up to support them later on.
That said there are a couple of important benchmarks you can work toward as you increase your retirement savings. The first is your employer match – if your company offers to match your plan contributions up to 6% of your paycheck, aim to contribute at least that much (because hey – free money). The second is maxing out your yearly contributions, which is a different amount based on the type of plan you have. The more money you can sock away into a tax-deferred account, the less your savings can be eroded by taxes over the years.
How do I balance retirement savings with student loans and other debt?
If you’re paying off debt, even saving a little each month can feel like a stretch. A good rule of thumb is to weigh the interest you’re paying on debt with the expected interest and returns you could receive on your investments (long-term historical market returns can be a good gauge). For this reason, it’s usually best to pay off high interest rate credit cards and student loans first – the interest you’re paying on that debt will likely eclipse whatever returns you make on the savings side.
And if there are opportunities to lower the interest rate on any of your debt, now’s the time to do it. For example, check to see if you’re eligible to refinance and consolidate student loans at a lower rate, and look into low rate personal loans to consolidate credit card debt at a lower rate. Eligibility for these options is usually dependent on financial factors like your credit score, which means that the more you take care of your finances, the more they’ll take care of you.
Once you get to a point where you’re only dealing with low interest rate student loans, most experts agree that it’s okay to split your focus between paying off your loans and putting money into retirement savings – particularly if you have a high debt load that’s going to be around for a while. Just remember that the sooner you start, the more you’ll benefit from the effects of compounding, so waiting to be debt-free can be a dangerous thing.
Bottom line, if you save what you can and continue to make responsible financial decisions in other parts of your life, you should be in good shape.
This article is designed to provide useful information about personal finance, but it is not intended to provide legal or tax advice.