When you're working, retirement can feel like it's a long way away—especially if you barely make ends meet. In that situation, you likely want to put what little extra money you have toward what you need now, not what you'll need later.
Balancing these priorities gets trickier with time and additional responsibilities. However, saving what you can as early as you can makes a huge difference. This will not only maximize what your employer may offer you but also how much money you'll have when you retire.
The Power Of Interest
Say you're 22 years old and earning $40,000. If you put 10% of that $40,000 into a 401(k) that gets a 3% employer-matching contribution, you could have a nest egg of $1.7 million by age 65. That's not accounting for any raises or increased contributions over time either.
If you wait until you're 32 to begin saving, the same contributions grow to only $780,000. And that's just a 10-year difference. Imagine how much less you'd have if you wait until you're 42. Of course, this doesn't mean you shouldn't save if you're older. You just may need a different strategy.
To make the most of your retirement fund, the first thing to do is find out what kind of retirement benefits your employer offers. One of the most popular options is a 401(k) plan. This is a retirement plan that allows you to take pre-tax dollars out of your paycheck and put them into your retirement account.
For example, if you're in the 25% tax bracket and put $100 in your 401(k), you'll save $25 in taxes. Your 401(k) account grows by the entire $100, but your paycheck only decreases $75. This is also known as "deferring taxes."
Another advantage to a 401(k) plan is that many employers match part of their workers' contributions. The most common match is 50% up to a maximum employee contribution of 6%. That means if you save 6% of your annual salary, your employer will match half of it (3%). It's like someone offering to give you $5 for every $10 you set aside. In other words, you're getting free money.
Employers And 401(k)s
One thing to remember about 401(k) plans is that they're tied to your employer. So, when you leave a job, your 401(k) stays put until you decide what to do with it. The smart thing to do is to either roll it over to your new employer's 401(k) or roll it over to an individual retirement account (IRA) that you create anywhere you want (more about IRAs in a minute).
Simply ask your former employer's HR person for the forms to initiate the rollover. You don't have to do this immediately, but it's better to do it sooner than later. Your employer or 401(k) may automatically give you a cash dispersal if you don't roll over your old 401(k) in a certain period of time. This is especially true if you have a small balance. If this happens, you'll pay taxes on that money, as well as a 10% penalty.
What if your employer doesn't offer a 401(k) plan? Ask your human resources team if they have a different retirement plan, like a 403(b) or a 401(a), and offer any type of contribution. If they don't, consider opening a Roth IRA to help hit your retirement goals. The money you contribute to a Roth will be taxed as part of your normal paycheck, but you can withdraw the money without incurring any tax penalties. Note that you can open a Roth IRA in addition to any employer plan you contribute to.
If you’re self-employed, you can still have a plan for retirement savings. Your options include a Simplified Employee Pension (SEP IRA), a Savings Incentive Match Plan for Employees (SIMPLE IRA), and an Individual 401(k) (also known as solo 401(k) or a self-employed 401(k)).
Where To Invest Your Retirement Funds
Once you've set up your retirement plan, you have to decide where specifically you want to invest your money—stocks, bonds, or cash. Investing in the stock market might sound like something you don't want to deal with, and given how up and down the economy can be, you may even be scared to invest. The reality, though, is that it's much simpler—and less scary—than you may think. All you have to remember is to keep things simple.
The main thing to do is make sure you diversify your investments. All that really means is that you shouldn't put all of your money in the same type of funding option (such as growth stocks or value stocks). Having a diverse portfolio helps lower your investment risk because even if some of your holdings go down, others will likely go up.
Most 401(k) plans offer what are called "target-date" mutual funds based upon the year you predict you'll retire. These funds essentially create a diverse portfolio for you. They automatically adjust their investments over time. When you're young and retirement is far off, they're aggressive. As you get closer to your retirement date, your target-date fund will get more conservative.
Take Your Time
If you feel overwhelmed or confused right now, that's OK. All you have to do is ask for help. Your employer can put you in touch with a representative from your 401(k) company who will be happy to help you choose investments at no charge. Take advantage of it. If your employer doesn't have this option, seek out a certified financial planner or adviser for advice.
The bottom line, however, is that you should set up a retirement fund and start contributing as soon as you can. Don't get hung up on how much you'll eventually need. Just start saving. If you can only afford $50 a month, that's fine. Every little bit helps in the long run.