Often the phrase itself, “saving for retirement,” sounds daunting and so far off in the future that you may find yourself thinking, “Why do I need to care about this now? I’ve got 30+ years until I need to worry about that time of my life…”
Well, fortunately, “There’s no better time than the present” rings true when talking about saving for retirement. To really enjoy those retirement years, it’s a good idea to start saving sooner rather than later.³ But how and where should you go to get started? Let’s take a look at some of the basics of saving for retirement:
- What are some of the different ways to save for retirement
- Which type of retirement savings account should I consider investing in?
- How much should I contribute to my retirement savings accounts?
- When should I start saving?
What are my retirement savings options?
When it comes to talking about retirement savings there are a lot of fancy sounding names that get thrown around like “Roth” and “401(k)”and important-sounding words like “tax advantaged,” and at times it can all get a bit confusing. So, let’s break this down. First let’s start with the who and what of retirement savings.
Retirement savings accounts can be generally grouped into two different buckets, Individual Retirement Accounts (IRAs) and the 401(k).
What is an IRA?
IRAs are long-term investment accounts with various tax benefits that allow you to save specifically for retirement. Why the emphasis on individual? IRAs are retirement accounts specifically for an individual, meaning, each of us has our own IRA. This differs from the 401(k), which we will discuss below. While there are a handful of different types of IRAs, there are two main types that we will focus on: Traditional IRAs and Roth IRAs.
A traditional IRA is a type of long-term retirement savings account that allows you to contribute a portion of your salary pre-tax to the investment account.
One of the advantages of a traditional IRA is that the money you are contributing to the account has not yet been taxed. This allows you to contribute a larger portion of your salary that you can let grow for a longer period of time. You are not taxed on the contributions to a traditional IRA until you are of retirement age and you choose to withdraw the earnings.
There are typically penalties for early withdrawal of contributions or earnings from a traditional IRA.
Similar to the traditional IRA but with different tax benefits, is the Roth IRA. With a traditional IRA you can contribute a portion of your salary pre-tax to the investment account, but on the flip side, with a Roth IRA you contribute after-tax income.
This type of retirement account is another tax advantaged account. Meaning, once you contribute after-tax income to the Roth IRA, your money grows tax free, and you are not taxed on the money when you take it out in your retirement years. This is a great advantage to the Roth IRA.
Contrary to the traditional IRA, Roth IRAs typically have less penalties associated with the early withdrawal from the account, and generally allow you to take your contributions (the money you put into the investment account) out at any time without penalty and tax free.
What is a 401(k) and how is it different from an IRA?
A 401(k) differs from an IRA in that it isn’t an individual account like a traditional IRA or Roth IRA. A 401(k) functions like a traditional IRA in that it has certain tax advantages, but it is a company-sponsored retirement savings account. Therefore, it gets its own bucket as your employer is sponsoring it.
An advantage of a 401(k) is that often employers offer a company ‘match’ up to a certain percent of your contributions. Let’s say your annual salary is $50,000 and you contribute 10% ($5,000) of your pre-tax salary to your 401(k). Meanwhile, your employer offers a matching program, whereby the employer will match 100% of your contribution up to 6%. In this example, your contribution of $5,000 to your 401(k) would be increased by your employer’s match of $3,000 (6% of $50,000) for a total contribution to your retirement savings in that year of $8,000.
Which type of retirement savings account should I invest in first?
Now that we’ve established the main types of retirement savings accounts, let’s talk about how you decide which account is right for you. The crux of this decision falls on whether or not your employer offers a 401(k) matching program. Let’s explore those options below.
Option 1: My employer offers a 401(k) matching program.
Great! If your employer is offering a 401(k) match, then it’s important to consider starting your retirement savings adventure by investing in your 401(k). You’ll want to ensure you are working to contribute enough of your salary to meet the full benefits of the company match amount. More on this below.
Option 2: My employer doesn’t offer a 401(k) matching program.
Not a problem, but instead of starting with your 401(k), you will want to consider contributing to either a traditional IRA or a Roth IRA. The biggest benefit of a 401(k) is the matching program. So, while it’s great that your employer offers a 401(k), you may want to consider starting your retirement investing by contributing the max amount to a Roth IRA or Traditional IRA before contributing to your 401(k). By choosing to start with a Roth or traditional IRA, you allow yourself the ability to explore more low-cost investing options, which means that if you select those low-cost options, you will generally pay less in administrative fees than when you contribute to a 401(k). The more you pay in fees over time, the less you are earning in the long run.
Option 3: My employer doesn’t offer a 401(k) at all.
Not a problem. Follow the guidance in Option 2 above for how you can consider starting your retirement savings.
How much should I be contributing to my retirement savings account each year?
Now that we understand some of the different types of retirement savings accounts and which type of account you could consider starting your retirement savings journey with, let’s talk about how much you can contribute to each type of account.
If you’re starting with a 401(k)…
To truly reap the benefits of your employer’s matching program, you could initially work to contribute at least up to the employer match percentage. In using our example from above where the employer match was 6%, your initial goal would be to contribute at a minimum of 6% of your salary. Once you’ve contributed up to the employer match, you could then consider increasing your contribution annually by 1% each year until you reach 10% or the annual contribution max for an individual. For 2021, individuals (under the age of 50) can contribute up to $19,500 annually to a 401(k). For more information on contribution limits, see this link from the IRS here: *401(k) *contribution limits.
After making your contributions to your 401(k), and if you have the ability to, consider investing in a Roth IRA or traditional IRA as your next step. This could provide you with another tax-advantaged way to save for retirement. Remember to consider all contribution limits when determining where to invest next. Refer here for more information about limits on contributions and benefits. See below for more on contributing to your traditional IRA and Roth IRA.
If you’re starting with a traditional IRA or Roth IRA and you have a 401(k)…
The combined maximum contribution to both traditional IRAs and Roth IRAs is $6,000 in 2021 (for individuals under the age of 50).⁴ That being said, if you’re starting your retirement journey by contributing to a traditional IRA or Roth IRA, you could work to contribute the maximum amount of $6,000 annually to one of these account types. Once you’ve contributed the maximum amount, and you still have money left that you have set aside to invest in retirement, consider contributing this leftover amount to your 401(k).
If you’re starting with a traditional IRA or Roth IRA and you don’t have a 401(k)…
Consider following the same guidance as that mentioned above for those starting with a traditional IRA or Roth IRA but that have a 401(k). Again, you’re allowed to contribute up to the max amount each year.
When should I start saving?
There’s the saying, “The best time to start was yesterday, but the next best option is today.” This is spot on for how you should think about your retirement savings.
Maybe you’re in your 30’s and just now thinking about your retirement savings. Don’t waste time thinking about what you could have or should have done in your 20s, just start today.
And if you’re 20-something reading this and thinking, “ehh I’ve got time, I’m young.” While you may be young today, this doesn’t last forever, and it’s time to start saving now!
Don’t know where to start? Start with finding out if your employer sponsors a 401(k), and then follow our tips above and get to saving!
This blog is not intended to provide any tax, legal, financial planning, insurance, accounting, investment, or any other kind of professional advice or services. To make sure that any information or suggestions in this blog fit your particular circumstances, you should consult with an appropriate tax or legal professional before taking action based on any suggestions or information that we provide.