Let us be honest, everyone looks forward to the day that they can slow down and step away from their work desk. For some, that day is closer than for others. Regardless of your age, it is important to prioritize saving for your retirement. But what does that mean? If done correctly, your retirement account will generate an income to replace what you earned in wages. We refer to this transition in life as moving from “Man at Work” to “Money at Work”.
So how do you get there? The short answer is consistent, incremental savings. Of course, there is a lot more to it, such as how much to save, in what kind of account, and with what sorts of investments. Let’s explore what each of these important questions means to you.
1. How much should I save? Some financial wizards recommend a percentage like 10-15% of your annual income, but the truth is it depends! The first step of any investment decision is defining your time frame. In other words, how close are you to retirement? A 50-year-old trying to retire in 15 years may have to save significantly more per month than a 30-year-old with a 30+ year retirement horizon. You can use an online tool such as Kiplinger’s retirement savings calculator to determine your retirement savings goal. This is a great, comprehensive resource that includes lots of data points, even accounting for other retirement income like a pension or social security.
It is always a good idea to plan conservatively when it comes to your retirement income. You are planning to sustain your lifestyle for decades to come, so it makes sense to account for some extra cushion. This means you should (1) estimate a higher annual income than you think you will need (healthcare today is expensive), (2) assume a conservative investment return pre- and post-retirement, and (3) consider omitting income assistance like social security in your calculations. As the saying goes, we should under-promise and over-deliver!
2. What kind of retirement account is right for me? Again, it depends! (Are you sensing a theme here?) If you are an employee with a 401k/403b available through work, this is likely the best place to start. Oftentimes your employer will help you save, and they will match your contributions up to a certain percentage of your salary. This is an employee benefit, so get your free money and save AT LEAST up to the employer match! 401ks or 403bs are great because you can easily set up automatic monthly contributions right from your paycheck. Not much set-up work is required, and these types of accounts have a large annual contribution limit at $19,500 (2021) as opposed to a $6k limit in comparable accounts. The downfall is there are reduced investment options in employer plans, but the benefit of a large contribution limit and easy set up makes these accounts a no-brainer solution for W-2 employees.
If you are self-employed, there are unique retirement plan options available to you! The easiest solution is opening an IRA or Roth IRA. These do not require a plan administrator or strict paperwork guidelines like other alternatives. You can set up an account within minutes online and hold any investment available through your custodian. Though there is a lot of flexibility, you are limited to contribute only $6k (2021) per tax year (or $7k if you are over 50 years old). Still, either are a great starting place. In general, a Roth IRA is a good investment vehicle for young professionals since the after-tax contributions (no tax deduction on contributions unlike a traditional IRA, 401k or 403b) grow tax-free for life. For this reason, if you are eligible and have a long horizon until your retirement, investing in a Roth IRA is a great idea. Talk with your tax or investment professional when considering if a traditional or Roth IRA would offer you the greater benefit.
If you want to save more than $6k/year, you can consider a couple of different options such as an SEP IRA, a SIMPLE IRA, or a Solo 401k. Each have their own eligibility requirements and generally increased maintenance considerations. However, all offer anywhere from $14k - $58k in maximum annual contributions. In addition to saving for your retirement, you are also managing your taxable income by utilizing these tax-deferred strategies. A win-win that you should absolutely take time to consider.
3. How should I invest my retirement savings? The first step is to make sure you are investing your cash contributions! This seems obvious, but I have been surprised by how many people I meet with who have an IRA still sitting in cash from a rollover they made or from deposits that were never invested.
As mentioned, employer plans will have limited fund options, and oftentimes the default investment selection is a target date fund. Simply put, this is an automatically diversified fund that gradually becomes more conservative the closer you get to your “target” retirement date. These are a great option for just starting out, but some may have a high expense ratio (read: cost to carry) when there are less expensive index fund options available. You can read more about building an investment allocation here, but as a general rule, choosing the least expensive investments in a diversified manner will yield the best long-term results.
Retirement planning can feel overwhelming, but by answering the 3 questions in this article for yourself you should feel more in control of your future. It is never too soon or too late to start. Do not leave your retirement in the hands of the government or your employer. Create a plan today so that you can enjoy tomorrow.