When you ask, How much money do you need to retire? the answers you’ve probably heard may sound vast. Millions in retirement investment? Yeah, sure thing. On it.
When you have a family to take care of and other financial priorities like paying for rent or mortgage, covering the high cost of health care, paying down debt, building up an emergency fund and saving for your child’s college expenses, it can be easy to get lost in the numbers.
But often, the best way to save for retirement is to simply start. Take it a day at a time. Put one foot in front of the next.
Like many things, saving for retirement can be as simple or as complex as you want it to be. Here’s what you might need to know to get started:
Before even delving into how much to save for retirement, let’s start with where to put it. The two most popular retirement accounts are IRAs and 401(k)s.
An IRA (individual retirement account) is an account that any individual can open and contribute to with earned income. In other words, you can open this for yourself, regardless of your employer.
401(k)s, meanwhile, are employer-based retirement accounts with contributions deducted from your paycheck. Not all companies offer a 401(k), and you can only open this type of account if yours does. Some companies just offer you the option to contribute your own money, while other companies match their employees’ contributions.
A 403(b) account is very similar to a 401(k), except that it’s generally offered by nonprofit companies.
In 2018, the contribution limit for for IRAs is $5,500 per year, or $6,500 if you’re 50 or older. The contribution limit for 401(k)s is $18,500, or $24,500 if you’re 50 or older.
If your employer offers a match (for example, contributing a dollar for each dollar you add, or some other percentage), this is basically free money that can seriously help boost the money you’ve squirreled away in your retirement account. Unfortunately, about a third of employees don’t contribute enough to earn their full employer match, according to a 2013 survey from the American Benefits Council.
So if you can swing it, you’ll likely benefit a lot from maxing out your available match.
Some companies have a vesting schedule, which means you’d need to work at the company for a certain amount of time before receiving 100 percent of your employer’s contributions. So, first, you’d have to qualify for the match by making your own contributions. Then you’d need to keep working there for a certain amount of time to actually receive the money.
Ask your HR department about your employer-sponsored retirement plan and what it entails.
Both IRAs and 401(k)s come in two modes: Roth and traditional.
Contributions to Roth accounts are not deductible on your taxes, but the earnings and withdrawals you take when you’ve retired (after age 59.5) are tax free. So, if you make $50,000 and contribute $5,000 to retirement in a Roth account, you’d presumably have to pay income taxes on the full $50,000, including that $5,000 you contributed.
But then you can make withdrawals on both your contributions and your earnings without paying federal taxes, once you’ve met the age requirement (and you’ve held the account for at least five years).
Meanwhile, contributions to a traditional retirement savings account are made pre-tax (which means they’re taken out of your paycheck before you pay taxes, effectively reducing your income taxes for the year). This also means that any distributions taken during retirement are taxed as ordinary income.
Let’s take the same example: You make $50,000 and contribute $5,000 in a traditional account. This year, you’d only have to pay income tax on $45,000. But when you’re ready to retire, you’ll have to pay taxes on the full amount you withdraw, including any earnings you’ve made.
In many cases, a Roth account makes more sense and is better suited for younger people, since the assumption is that they’ll probably have higher incomes (and therefore higher tax rates) when they’re older and ready to retire. Therefore, it’s likely more beneficial for them to pay taxes now, while their rates are lower.
Meanwhile, older people and high earners are likelier to benefit from the tax perks of a traditional account, since they’re already in a high income tax bracket.
OK, yes, official recommendations on how much to save for retirement often range in the millions. The total amount you’ll need will vary depending on your income and how much it takes to support your desired standard of living, but you can play with a retirement calculator to figure out how much is appropriate for your situation.
The key to getting there may lie in focusing on the here and now. Instead of fixating on the total figure around how much to save for retirement, concentrate on the steps you can take today.
In particular, some experts recommend saving 15 percent of your income for retirement. If that feels too high, start with what’s realistic and increase that amount every year—or any time you get a raise.
The more money you set aside now, the better off you’ll be down the line.
If you need more help working through the details, a qualified financial planner can go over your assets, examine your situation and help you create realistic goals.
Once you’ve set up an IRA or 401(k), it’s time to starting deciding how you want to invest the funds within your account. If you’re an experienced investor, you might figure out your risk tolerance and choose your own mix of investments (your “asset allocation”) accordingly. From there, you’d need to rebalance your portfolio over time to make sure it’s still appropriate for you.
Here are the most common asset allocation models. The stocks mentioned in these can be a blend of domestic and international stocks as well as large, medium and small companies.
When putting together your asset allocation, index funds can be a great place to start. These are a favorite of investors looking for diversity in their portfolios. An index fund is a type of mutual fund (a pool of money from a specific group of investors) that’s meant to mirror a particular market index.
For example, an S&P 500 index fund will mimic the S&P 500, which includes 500 of the largest U.S. stocks. Generally, when companies in the S&P 500 do well, investors consider “the market” to have done well—and theoretically, if you’re invested in an S&P 500 index fund, the investments within your retirement account will have done well, too.
One of the biggest appeals of index fund investing is that index funds tend to have low fees, often much less than 1 percent of your investment. The lower the fees attached to your mutual funds, the more you’ll retain of your investments and any potential returns.
To pick the right funds, you can do research yourself, hire a financial planner through the National Association of Personal Financial Advisors or XY Planning, or use a robo advisor that chooses it for you.
If you don’t want to deal with all of that, target date funds are one of the most basic ways to manage your retirement investment. These mutual funds automatically rebalance your mix of investments (like stocks, bonds and other assets) the closer you get to retirement, so the funds will grow more conservative as you age.
When you start investing in your 20s, you’ll want to be aggressive and have a portfolio that contains lots of stocks. As you get older, you’ll want to choose more bonds, which are less volatile. Think of target-date funds as “set it and forget it” investing.
These funds are organized by the year in which the investor hopes to retire. For example, if you’re hoping to retire in about 40 years, you’d likely choose a 2055 or 2060 target-date fund.
Keep reminding yourself that it’s not about doing everything at once, it’s about simply starting.
If you are new to saving for retirement, aim to spend 15 minutes each week putting your plan into action. That could mean anything from emailing your HR department about your 401(k) to calling a potential financial planner.
A few minutes here and there will make all the difference down the line.
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