It can sometimes feel like there’s no good time to start a retirement savings plan. If you’re in your 20s or 30s, you might have financial pressures from weddings and cars, to first homes and kids. Perhaps you’re launching a business. And of course, there’s student loan debt.
No matter how old you are, it might be tempting to think, “I’ll do it with my next job, or after my next raise.” But for everyone, the sooner you get a head start on planning for the future, the more opportunity you have to grow your retirement savings. Learn how to set up a retirement fund and why it matters.
Why You Should Start a Retirement Fund
There are many reasons for starting a retirement account now. Thanks to rising life expectancy, most of us will likely spend more time in retirement than our parents and grandparents. The average life expectancy in 2020 was 78.81, up from 76.47 in 2000, and 74.89 in 1990.
At the same time, fewer workers have access to pensions and employer-sponsored plans, and the future value of Social Security benefits is uncertain. Opening a retirement fund matters for making sure you’re financially prepared.
The earlier you start building your nest egg, the more your savings will grow. Thanks to the power of compound interest, the length of time your money is invested can play a huge role in the amount you end up with. That’s because with compound interest, you earn interest on top of the interest you’ve already earned—not just on top of your initial contributions.
For example, say you invest $10,000 and earn a 5% annual return on that investment each year. You invest an additional $500 a month for 10 years, earning the same rate of return. Compounding interest would make your account worth $91,756, representing a gain of $21,000 and change on a $70,000 investment. After 20 years, that would grow to nearly $225,000, with $130,000 representing your contributions and the rest chalked up to compounding interest.
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How to Start a Retirement Fund
Starting a retirement fund takes some planning, particularly if you aren’t used to setting money aside consistently.
Having a blueprint to follow for starting a retirement account can make it easier to begin working toward long-term financial goals. It can also help you avoid some of the most common retirement mistakes people make when putting together a retirement planning strategy.
If you’re starting from square one with retirement saving, here are the most important steps to know when opening a retirement fund.
1. Calculate How Much You Need to Save
Starting a retirement fund begins with considering your needs, goals, and ability to save. A good way to assess how much money you need to save for retirement is by asking yourself a few questions:
• What is your target retirement date?
• Do you plan to stop working at age 65, or will you continue working full-time or part-time?
• Based on current life expectancy, how many years do you expect to spend in retirement?
• What kind of lifestyle would you like in retirement?
• Do you anticipate your living expenses will be higher or lower than today?
Once you’ve considered these questions, it can help to consult a retirement calculator. This tool will help you figure out much you need to sock away, given your age, how much you’ve already saved, and other factors.
A common rule of thumb is that you should have the equivalent of your yearly salary saved by age 30 and twice your annual salary saved by age 35. But those are ballpark benchmarks—the amount you have saved at those ages may depend on when you get started saving for retirement, how much you save each year and how much your money grows as you invest it.
2. Choose a Retirement Plan Option
Once you know how much you should be saving, the next step is opening a retirement fund. Generally speaking, a savings account isn’t the most lucrative place to save money for retirement—the national average interest rate is currently .05%, according to the FDIC . People typically get larger returns by investing their retirement savings in other financial vehicles.
Not only do savings account rates tend to lag behind what you could earn in the market, but inflation, or the overall increase in the price of goods and services, can diminish the value of the interest you’re able to earn with a savings account over time. If you’re leaning toward keeping your emergency fund or other liquid cash in a savings account, look for a high-interest savings option which can yield the best rates.
There are several types of retirement accounts to choose from, all of which allow you to invest your funds in a variety of assets. The one you should pick depends on your personal situation.
401(k)
A 401(k) is an employer-sponsored retirement plan (some non-profit employers offer a 403(b) instead) in which an employee contributes regularly to their retirement savings with pre-tax dollars. In some cases, employers offer to match employee contributions up to a certain amount. This is essentially free money account holders can use to grow wealth for retirement.
Employees can contribute up to $20,500 to their 401(k) plans in 2022, with deductions taken straight from their paycheck, which makes it easier to stay on track (sort of a “set it and forget it” mentality). What’s more, a 401(k) is tax-advantaged, meaning the more you contribute, the lower your taxable income for IRS purposes. While there are tax savings on the front end, you can expect to pay income tax on withdrawals in retirement.
Some employers offer a Roth 401(k) option as well as a traditional 401(k). With a Roth 401(k), contributions are made using after-tax dollars. This allows investors to make qualified withdrawals in retirement tax-free. But you would still be subject to required minimum distributions beginning at age 72, the same as you would with a traditional 401(k).
IRA
While a 401(k) is offered through an employer, individuals can open an IRA, or an individual retirement account, on your own. This can be a good option for people who don’t have access to a retirement plan at work. Compared to a 401(k), an IRA usually offers a wider variety of investment options and allows an individual to select institutions and funds with lower fees.
Most people have heard of IRAs and Roth IRAs, though they may not know the differences between them. Here’s a summary—along with info on another type of IRA, SEP IRA.
• A traditional IRA lets you set aside up to $6,000 a year in pre-tax dollars (or $7,000 if you’re 50 or older). As with a 401(k), you’ll pay taxes on the money you withdraw in retirement.
If you withdraw funds before age 59½, you will pay a 10% penalty (excluding certain exceptions including first-time home purchases, qualified educational expenses, unreimbursed medical expenses). At age 72, you are required to withdraw a minimum amount every year (known as an RMD, or required minimum distribution). Generally, a traditional IRA might be appealing for people who expect to be in a lower tax bracket when they retire, or for those who tend to owe a lot on their taxes.
• A Roth IRA also allows you to contribute up to $6,000 a year in post-tax dollars (or $7,000 if you’re 50 or older). This means that while there are no tax advantages for contributions, you won’t pay taxes on the money you withdraw in retirement.
There are eligibility requirements with a Roth IRA: You must fall below the income limit ($129,000 for a single person, or $204,000 for a married couple filing jointly, in 2022) to contribute the maximum amount to a Roth IRA. If you do qualify, one advantage over an IRA is that you can withdraw the contributions (but not earnings) without penalties or taxes at any time. A second is that there are no RMDs. It might make sense to consider a Roth IRA if you’re likely to be in a higher tax bracket when you retire, or if you usually get a refund at tax time.
• A SEP IRA is designed for people who are self-employed or own small businesses. It’s similar to a traditional IRA in that contributions are tax-deductible. But you can often contribute much more than to a traditional IRA: For 2022, that’s up to 25% of your income, or $61,000, whichever is lesser.
Brokerage Accounts
You can also save for retirement by opening a brokerage account. While they won’t have the same tax advantages as a retirement account, general brokerage accounts don’t have limits on how much you can contribute or when you can take money out.
A brokerage account can be a good option for starting retirement savings if you want to contribute more than annual limits allow or take advantage of other benefits. Unlike retirement accounts, SoFi Invest®, for example, allows you to invest in exchange traded funds (ETFs), which offer a diversified mix of stocks and bonds at low fees.
3. Start Investing
The assets you choose to invest in will likely depend on a variety of factors. When choosing exchange-traded funds (ETFs), mutual funds, or stocks, here are some important considerations:
• Your age
• Time horizon for investing
• Risk tolerance
• Amount you’re comfortable investing
• How hands-on (or hands-off) you’d like to be
ETFs and mutual funds can offer a simplified investing package, since one of the benefits of an ETF, and a mutual fund, is that the selection of stocks and bonds will provide diversification. Trading individual stocks, on the other hand, has the potential to yield higher returns.
When weighing stocks, mutual funds, or ETFs side by side, consider each one’s past performance and risk profile. With mutual funds and ETFs, pay attention to the expense ratio so you understand how much it will cost you to own a particular fund each year. A lower expense ratio will mean you get to keep more of the returns earned.
Estimate how much of your income you can afford to invest each month, based on your regular expenses, debt payments, and other money you’re allocating to savings. Aiming to save and invest 10% to 15% of what you earn is a good ballpark goal but you may want to tweak the number if it’s not a realistic target for you.
Finally, keep in mind that you also have a choice between passively and actively managed funds. Keep reading to learn the major pros and cons of each investing strategy.
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Passive Investing vs. Active Investing
Passively managed funds, usually index funds or ETFs, track the performance of a certain index, such as the S&P 500. These funds usually offer lower fees than actively managed portfolios.
With active investing, your portfolio’s performance doesn’t necessarily depend on how an underlying benchmark performs but on the decisions made by you (or your fund manager) regarding how and where you invest. For example, you might build a portfolio that includes stocks from your favorite companies or actively managed ETFs.
Pros and Cons of Passive Investing
Passive investing may appeal to you if you prefer more of a hands-off approach to building a portfolio.
| Pros | Cons |
|---|---|
|
• Potentially lower investment costs • Track the performance of an underlying benchmark through the use of index funds • Simplified diversification • Doesn’t require advanced investment knowledge |
• Returns can meet the market but typically don’t beat it • Passive investing is not risk-free so you could still lose money with this strategy |
Pros and Cons of Active Investing
This type of investment approach might appeal to you if you’d rather be hands-on in shaping your portfolio over time. You can tailor which stocks or funds you purchase or sell to your goals and risk tolerance, giving you flexibility.
| Pros | Cons |
|---|---|
|
• You’re in control of choosing your investments • An active portfolio may outperform a passive portfolio, depending on how you choose to invest • Online investment platforms like SoFi Invest make it easy to get started with active investing with low costs |
• Active investing can be risky and returns aren’t guaranteed • If you’re investing in actively managed funds, those can carry higher investment costs than passively managed funds |
The Takeaway
Starting a retirement savings plan is one of the most important financial steps you can take in adulthood. The sooner you start, the sooner you can begin saving money for retirement—and rest easy with the knowledge that you are taking care of your future self.
There are many ways to save for retirement — whether by contributing to an employer-sponsored plan, an individual retirement plan, or by investing your money in a brokerage account.
If you have an old retirement plan from a previous job, you can also think about rolling over that old 401k to an IRA. Doing a 401k rollover can help you manage your retirement funds all in one place.
SoFi makes the rollover process seamless and simple — with no need to watch the mail for your 401(k) check. There are no rollover fees, and the process is automated so you can complete your 401(k) rollover quickly and easily.
SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
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