Retirement may seem far off in the future, and you probably have many other things you want to save for and spend your money on in the meantime. But if you want to retire someday, you need to think about retirement now. Learn a bit about it and you’ll be glad you did. It may even be simpler than you thought. Start by deciding if you are ready to save for retirement. From here, set up a retirement account with automatic contributions, and let it grow.
Advantages of a 401(k)
A 401(k) is a retirement account that allows you to save money for retirement and offers tax benefits that allow you to keep more of your money. With a 401(k), you don’t pay taxes on the dividends your money earns. You can also decide when you pay taxes on your contributions: when you put the money in at the beginning or when you take it out at retirement (called Roth or Regular contributions). There are restrictions set by the government including a limit to how much you can contribute each year. You will also face fees if you take the money out prior to retirement. But when you use it as intended, contributing and leaving the money in the account to grow, it can be a great tool to prepare for retirement.
Time to Save
Before you start contributing to your 401(k) ask yourself these questions. First, do you have an emergency savings fund? Read my article on what an emergency savings fund is, how much to save, and why it is so important to have. Next, do you have high interest consumer debt that you need to pay off, such as credit card debt or student loans? Work on that before you contribute to your 401(k). However, if your employee offers matching, take advantage of that if you can, but more on that later.
Calculate what you can afford to contribute
Aim for at least 10% of your income. If that is currently out of reach, contribute what you can- it will add up over time. If you can do more than 10% and it is within the contribution limit ($19,000 for 2019), go for it. By saving and investing you’ll get the benefit of compound earning.
Your employer may offer matching contributions to your 401(k). If you contribute an amount, your employer may contribute the same amount to your 401(k). If they offer this benefit, take advantage of it, it’s free money.
Roth vs Regular
You’ll have the option to choose Roth or Regular deductions to your 401(k). The difference is if you pay taxes now as the money is deducted from your pay or later when you withdraw the money from the retirement account. If you are in a high tax bracket, making a high salary, you might want Regular to pay taxes in retirement when your income and tax bracket will probably be lower. Keep in mind tax rates might be higher when you retire. If you aren’t in a high tax bracket, you might choose Roth and take the taxes out now. You might even decide to do some of both, deduct some pre-tax (Regular) and some post-tax (Roth).
Pay yourself first. Make it an automatic deduction from your paycheck to go right into your 401(k). This simplifies the process so you don’t have to remember to make a contribution and you aren’t tempted to spend the money.
It is very important that you invest your 401(k). Disclaimer, there is no guarantee of future performance of the markets, this is my personal opinion and not professional advice. With that said, diverse funds generally have resulted in higher returns than money market accounts which in the past have had low returns. You may decide to invest in a target date fund, which has a mixture of stocks and bonds with a level of risk that corresponds with how soon you’ll retire. Generally people who don’t plan to retire for decades can take more risk in hope of higher returns. If the market doesn’t do well, you have time to wait for the market to pick up again. With a target date fund you just pick when you plan to retire and the fund managers select the individual stocks and bonds for you. So once you set up automatic deductions and send it right into your fund, there isn’t much more you need to do. Simple!
Talk to your employer or HR representative about setting up a 401(k) and if they offer a matching program. Decide how much you can contribute and make it a regular automatic deduction from your paycheck. Invest your 401(k) in diversified funds and let it grow. Don’t take money out of your retirement account early but instead contribute what you can now to utilize compound growth. These simple and important steps can help you prepare for life’s expenses in retirement, get started today.