Written By Ron Lieber @ronlieber. Taken from the New York Times
While most workers are responsible for their own retirement savings these days, high schools don’t have required classes on 401(k)’s and Individual Retirement Accounts (I.R.A.s). And colleges usually don’t teach anything about Roth I.R.A.s or 403(b)’s. That’s where we come in. Here is what you need to know about saving for life after you stop working and getting on the path toward a comfortable retirement, no matter your career or the size of your paycheck.
The best day to start saving is today, even if you can save only a little bit.
The most important advice about saving for retirement is this: Start now. Why? Two reasons:
1.The magic of compound interest. You’ve probably read about this before, but the best way to understand it is to see it in front of you.
Yes, we did that math correctly. If two people put the same amount of money away each year ($5,000), earn the same return on their investments (6 percent annually) and stop saving upon retirement at the same age (67), one will end up with nearly twice as much money just by starting at 22 instead of 32. Put another way: The investor who started saving 10 years earlier would have about $500,000 more at retirement. It’s that simple.
2. Saving is a habit. It may make rational, mathematical sense to start saving early, but it isn’t always easy. But the instinct to save grows as you do it. It’ll start to feel good as you see that account balance grow.
HOW MUCH SHOULD YOU SAVE?
The short answer: As much as you reasonably can, says Carl Richards, our Sketch Guy columnist. Sure, you’ll see articles telling you to save at least 15 percent of your income; that’s a fine benchmark, though the true number will depend on how long you hope to work, what kind of inheritance you may get and a bunch of other unknowable facts. So start with something, even if it’s just $25 per paycheck. Then, try to save a little bit more each year. Do it early and often enough so that saving becomes second nature.
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Understanding Your Investment Account Options
Now that you’ve made the right choice in deciding to save for retirement, make sure you are investing that money wisely.
The lineup of retirement accounts is a giant bowl of alphabet soup: 401(k)’s, 403(b)’s, 457s, I.R.A.s, Roth I.R.A.s, Solo 401(k)’s and all the rest. They came into existence over the decades for specific reasons, designed to help people who couldn’t get all the benefits of the other accounts. But the result is a system that leaves many confused.
The first thing you need to know is that your account options will depend in large part on where and how you work.
IF YOU WORK AT A FOR-PROFIT EMPLOYER
Available account: 401(k) plan.
If your for-profit employer offers any workplace retirement savings plan, it’s probably a 401(k). (Many smaller employers do not.) You can generally sign up for this any time (not just during your first week on the job or during specific periods each year). All you have to do is fill out a form saying what percentage of your paycheck you want to save, and your employer will deposit that amount with a company (like Fidelity or Vanguard) that will hold it for you. Here, automation is your friend. Some employers will automatically raise your savings rate each year, if you let them. And you should.
Things to Know About a 401(k)
Matching: If you’re really lucky, your employer will match some of your savings. It may match everything you save, up to 3 percent of your salary. Or it may put in 50 cents for every dollar you save, up to 6 percent of your salary. Whatever the offer is, do whatever you can to get all of that free money. It’s like getting an instant raise, one that will pay you even more over time thanks to the compound interest we were talking about before.
Caps: How much can you put aside in a 401(k)? The federal government makes the call on this, and it often goes up a bit each year. You can find the latest numbers here.
Taxes: As with most other employer-based plans, when you save in a 401(k) you don’t pay income taxes on the money you set aside, though you’ll have to pay taxes when you eventually take out the money.
IF YOU WORK AT A NONPROFIT EMPLOYER
Available accounts: 401(k), 403(b) and 457 plans.
If you work for the government or for a nonprofit institution like a school, religious organization or a charity, you likely have different options.
What to Know About a 457 plan: These are a lot like 401(k)’s, so read the section above to understand them better.
What to Know About a 403(b) plan: These frequently show up at nonprofits – 401(k)’s are more rare here – and often get complicated and expensive. You may be encouraged (or forced) to put your money into an annuity instead of a mutual fund, which is what 401(k) plans invest in. (More on mutual funds later.) Annuities technically are insurance products, and they are very difficult even for professionals to decipher. Which brings us to the expensive part: They often have very high fees.
In some instances, especially if your employer is not matching your contribution, you may want to skip using 403(b)’s altogether and instead use the I.R.A.s we discuss below.
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A 403(b) plan is similar to the more familiar 401(k), but it is subject to less stringent securities regulations.
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IF YOUR EMPLOYER OFFERS NO PLAN OR YOU’RE SELF-EMPLOYED
Available accounts: I.R.A., Roth I.R.A., S.E.P. and Solo 401(k) plans.
People who are setting up their own retirement accounts will usually be dealing with I.R.A.s, available at financial-services firms like big banks and brokerages.
What to Know About I.R.A.s:
Choosing where to start an I.R.A.: Ask the financial institution for a complete table of fees to see how they compare. How high are the fees to buy and sell your investments? Are there monthly account maintenance fees if your balance is too low?
In general, what you invest in tends to have far more impact on your long-term earnings than where you store the money, since most of these firms have pretty competitive account fees nowadays.
Caps: As with 401(k)’s, there may be limits to the amount you can deposit in an I.R.A. each year, and the annual cap may depend on your income and other circumstances. The federal government will adjust the limits every year or two. You can see the latest numbers here.
Taxes: Perhaps the biggest difference between I.R.A.s has to do with taxes. Depending on your income, you may be able to get a tax deduction for your contributions to a basic I.R.A. up to a certain dollar amount each year. Again, check the up-to-date government information on income and deposit limits and ask the firm where you’ve opened the I.R.A. for help. After you hit the tax-deductible limit, you may be able to put money into an I.R.A. but you won’t get any tax deduction. As with 401(k)’s, you’ll pay taxes on the money once you withdraw it in retirement.
What to Know About Roth I.R.A.s:
The Roth I.R.A. is a breed of I.R.A. that behaves a little differently. With the Roth, you pay taxes on the money before you deposit it, so there’s no tax deduction involved upfront. But once you do that, you never pay taxes again as long as you follow the normal withdrawal rules. Roth I.R.A.s are an especially good deal for younger people with lower incomes, who don’t pay a lot of income taxes now. The federal government has strict income limits on these kinds of everyday contributions to a Roth. You can find those limits here.
What Are S.E.P.s and Solo 401(k)s?
Another variation on the I.R.A is aS.E.P. (which is short for Simplified Employee Pension), and there is also a Solo 401(k) option for the self-employed. They came with their own set of rules that may allow you to save more than you could with a normal I.R.A. You can read about the various limits via the links above.
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WHAT HAPPENS IF YOU CHANGE JOBS?
When you leave an employer, you may choose to move your money out of your old 401(k) or 403(b) and combine it with other savings from other previous jobs. If that’s the case, you’ll generally do something called “rolling the money over” into an I.R.A. Brokerage firms offer a variety of tools to help you do that, and you can read more about the process here.
That said, some employers will try to talk you into leaving your old account under their care, while new employers may try to get you to roll your old account into their plan. Why do they do this? Because the more money they have in their accounts, the less they have to pay in fees to run the program for all employees.
But leaving your money behind or rolling it into your new employer’s plan may have disadvantages. Most employer plans may have only a limited menu of investments, but your I.R.A. provider will generally let you invest in whatever cheap index funds you want.
Also, it’s generally best to keep all of your retirement money in one place; it’s easier to keep track of it that way. So, roll all your retirement accounts into an I.R.A. once you leave a company to simplify things, especially as you near retirement. You can’t count on former employers to keep in touch as your home or email addresses change. Nor will every entity that has an account in your name necessarily track you down when you near retirement.
How to Invest Your Money
You don’t need to be financially savvy to make smart investment decisions.
DON’T GET FANCY
Dozens of books exist on the right way to invest. Tens of thousands of people spend their careers suggesting that they have the best formula. So let us try to cut to the chase with a simple formula that should help you do just fine as long as you save enough.
Think humble, boring, simple and cheap.
Humility comes first. Yes, there are people who can pick stocks or mutual funds (which are collections of stocks, bonds or both) that will do better than anyone else’s picks. But it’s impossible to predict who they will be or whether the people who have done it in the past will do it again. And you, researching stocks or industries or national economies, are unlikely to outwit the markets on your own, part-time.
THE BORING GLORY OF INDEX FUNDS
Your best bet is to buy something called an index fund and keep it forever. Index funds buy every stock or bond in a particular category or market. The advantage is that you know you’ll be capturing all of the returns available in, say, big American stocks or bonds in emerging markets.
And yes, buying index funds is boring: You usually won’t see enormous day-to-day swings in prices the same way you may if you owned Apple stock. But those big swings come with powerful feelings of greed, fear and regret, and those feelings may cause you to buy or sell your investments at the worst possible time. So best to avoid the emotional tumult by touching your investments as little as possible.
HOW TO CHOOSE INDEX FUNDS
How much of each kind of index fund should you have? They come in different flavors. Some try to buy every stock in the United States, large or small, so that you have exposure to the entire American stock market in one package. Others try to buy every bond a company issues in a particular country. Some investment companies sell something called an exchange-traded fund (E.T.F.), which are index funds that are easier to trade. Either flavor is fine, since you won’t be buying or selling the funds much anyway.
As to your own allocation between, say, stock funds and bond funds, much will depend on your age and how much risk you’re comfortable taking. Stock funds, for instance, tend to bounce around more than bond funds, and stocks in certain emerging markets tend to bounce around more than an index fund that owns, say, the stock of every big company in the United States (or every one on earth).
Get Help: Most employer-based plans, like 401(k)’s and even plenty of 403(b)’s, contain target-date mutual funds. These are baskets of funds that may contain some combination of stocks and bonds from different size companies from all over the world. You can choose one of these funds based on the year you hope to retire — the goal year will be in the name of the fund. So, if you’re 40 years from retirement, you’d pick a fund with the year in the name that is closest to 40 years from now. Then, the fund slowly changes the mix of funds over time so it gets a bit less risky with each year, as you get closer to the period when you’ll need the money.
No Help Available? If you’re on your own, one option is to pick a single target-date fund made up entirely of index funds and just shovel all of your retirement savings into that. That way, you have all of your savings portioned into an appropriate mix that the fund manager will adjust as you get older (and presumably less tolerant of risky stocks).
Some companies called roboadvisers offer a different service. These robots will first ask you a series of questions to gauge your goals and risk tolerance. Then, they’ll custom-craft a portfolio of cheap, indexed investments.
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THE DOWNSIDE OF RETIREMENT ACCOUNTS
Retirement accounts are not free, and the fees you pay eat into your returns, which can cost you plenty come retirement. If you are employed, the company that runs your plan (and whose name appears on the account statements) is charging your employer fees for the service. Plus each individual mutual fund in the plan has its own costs. If you are self-employed, you’ll be charged for your I.R.A. at the mutual fund level and then pay whatever fees (if any) that the brokerage firm levies on an annual basis or for each trade you make in your account.
Yet another reason to pick index funds: Index funds tend to be the cheapest investments available, in addition to doing quite well over time when compared to other funds run by people trying to outperform everyone else’s market predictions. So investing in index funds is like winning twice.
If you want to learn more about identifying and deciphering retirement account fees, start with this series of stories. But because most of us don’t have much context for what is reasonable, employees of large organizations should turn to Brightscope for its rankings of thousands of employer-based plans.
If you’re saving on your own and are curious about a particular target-date mutual fund and its fees, you can check its ranking on Morningstar and compare it to other funds. As for those roboadvisers, the funds they’ll put you in are usually quite cheap. You’ll usually pay another quarter of a percentage point of your balance each year in exchange for their assistance in putting your portfolio together and keeping the investments in their proper proportions. You can absolutely save that money by handling those trades on your own. But the question you have to ask yourself is whether you’ll have the discipline to continue doing it year after year after year. If not, then that fee might seem like a reasonable price to pay for the help (and for keeping you from making bad trades).
FEES TOO HIGH?
Don’t like how high your fees are? You can try to lobby for better 401(k) or 403(b) plans.
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Routine Financial Tuneups
Once you set them up, it only takes a few minutes a year to keep tabs on your retirement accounts.
After setting up automatic savings from your paycheck, it’s easy to forget about it. (And if you do, that’s O.K. You’ll likely be pleasantly surprised when you do check in on your funds in a few years.) But, if you can spare an hour every year to check in on your accounts, you can ensure that you’re doing the best you can with your well-earned money.
1. Save 1 Percentage Point More from Your Paycheck
Time required: 5 minutes
If you followed our earlier advice, you set it up so you have money automatically taken out of each paycheck for your retirement account. You barely miss it, right? So increasing your savings by another percentage point probably won’t hurt your budget much. Over time, it could add up to six figures in additional savings.
2. Reconsider Your Investments
Time required: 30 minutes
Are you saving too much for a down payment or children’s college tuition but not enough for retirement? The home may be able to wait, and it’s easier to borrow money for a child’s education than it is to get loans to pay for your retirement expenses. Make sure you are investing wisely, for the most important things.
3. Rebalance Your Investments
Time required: 30 minutes
It’s been a great half decade for stocks. So if you set up accounts five years ago with the intent of having 70 percent of your money in stocks, the growth in those stocks may mean that your investments are now in a stock allocation that’s many percentage points higher. If so, it’s time to sell some stock and buy, say, more bond mutual funds to put things back into balance.
Getting Your Money When You Need It
For a 401(k) plan: It’s possible to get access to your money before you retire. Most 401(k) plans offer loans, where you can borrow from your investments.
The good news: If you receive a loan from a 401(k) plan, you pay interest to yourself.
The bad news: You may miss out on market gains during the repayment period. If you leave an employer before you’ve paid off the loan, you have to repay in full quickly, lest the loan turn immediately into an official withdrawal.
If you want to withdraw money from a 401(k) plan permanently before the legal retirement age, it may be possible depending on your plan. Such withdrawals are generally known as hardships, and you can read more about the rules for them here.
For an I.R.A.: With I.R.A.s, you have to start taking a certain amount of money out each year once you turn 70½. That’s the government’s way of forcing you into converting that money into income that it can tax, even if you don’t need the money right away. Roth I.R.A.s, however, are not subject to the same withdrawal rules. If you’re under 70, the early withdrawal rules require taxes and penalties, just as they do with a 401(k). But you can take some money out of some accounts for certain special occasion purposes, like buying a first-time home or paying college tuition. You can read more about the exceptions here.
ONCE YOU’RE RETIRED
Once you’re fully retired, how much can and should you take out each year? For many years, financial professionals figured that if you took out no more than 4 percent of your savings each year starting at age 65 or so, you stood a very good chance of outliving your money. But so much depends on the nature of your investments, your age, your health, your spending and charity goals and a host of other things. Given that, following a universal rule of thumb could be dangerous.
That’s why talking to a financial professional about your entire financial life as you approach retirement is probably a good idea. Make sure to speak to someone who agrees to act as a fiduciary, which means they pledge to work in your best interest. If you’re not seeking a long term relationship, find a financial planner who is willing to work by the hour or on a flat-fee project basis.
Before you pay anyone for financial help, however, do some careful work (with your partner, if relevant).
- What do you value most in life?
- How can spending and giving support those values?
- How much is enough when it comes to housing, travel and leisure?
- How much is too much?
Better yet, start thinking about those questions decades before retirement. The sooner your start, the calmer you’ll probably be about the money you do save and the more resolute you’ll be about putting enough aside to meet all your lifelong goals.
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We’ve tackled some of the most common questions about retirement saving.
WHAT ABOUT SOCIAL SECURITY?
Chances are, Social Security will still be around once you hit the eligibility age, but it probably won’t provide enough money, after taxes, for all the expenses you’ll face in retirement. Plus, it’s possible that some of the rules will change before it’s your turn to collect.
In general, if you can, you should wait until age 70 to take your Social Security money, since the monthly checks will be bigger at that point. So there may be a gap you need to bridge if you want or need to retire before you turn 70.
IF THERE ARE TWO ADULTS IN THE FAMILY WHO BOTH WORK, SHOULD THEY BOTH BE SAVING FOR RETIREMENT?
Yes. Two of the biggest potential expenses in retirement are health care and long-term care, like paying for a nursing home. You both may need above-average amounts of treatment and assistance, so more savings will mean more choices later on (and more tax breaks at present if you do save).
HOW DO I KNOW IF I’M SAVING ENOUGH?
You can’t, really. It’s hard to know how long you’ll want to work, how long you’ll be physically able to work, how long an employer or customers will be willing to let you work for them, how much money you’ll actually want to spend once you retire, and how long you’ll live when you’re done working. Plus, you can’t predict your investment returns.
Given all the variables, you may be tempted to throw up your hands and put off the decision to start saving or to increase your savings. Please don’t. If the possibilities feel overwhelming, just save as much as you reasonably can, as our Sketch Guy columnist, Carl Richards, puts it. Again, more savings now will mean more and better options later.
THIS IS HARD. HOW DO I FIND A FINANCIAL ADVISER WHO CAN HELP?
The standard advice is to talk to someone you trust and see whom they use and like. But plenty of smart people know very little about money and have no idea if a financial adviser is treating them poorly.
First find a few advisers to interview. Two good places to start are the National Association of Personal Financial Advisors (Napfa) and the Garrett Planning Network. Members of both organizations tend to be transparent about their fees. Sure, there are some bad seeds in these two groups (as there are everywhere), and there are plenty of great advisers who work for more traditional brokerage firms (who are not members of the two groups). But your odds of quickly finding someone good will be high in these two organizations.
There are some other hints that can help you find a good adviser. Check their certifications. If an adviser is a certified financial planner (C.F.P.) or chartered financial analyst (C.F.A.), that means that he or she has learned a lot along the way and passed some difficult exams to earn those initials. (Other titles and acronyms may mean much less.)
Then set up an initial meeting with a few advisers. Ask each if he or she pledges to act in your best interest, always. The fancy term for this is acting as a “fiduciary,” and by all means ask your adviser to take the fiduciary pledge we created a few years back.
Then, ask a potential adviser questions about the fees you’ll be paying — to the adviser, for your investments and anything else. Here are 21 questions to get you started. Check an adviser’s industry disciplinary records, too.
Finally, compare your notes about each adviser you spoke to. Be real about how real you’re going to need to get with this stranger. So much of these money conversations are about feelings: our fears, our goals and our strongest values expressed through our spending, saving and giving. Does this person care about your feelings? Are the people you’re talking to even asking about them? If not, keep looking.