According to a recent ACCC Poll, 80 percent of respondents claimed that they do not know how to optimize their retirement funds. That is a very troubling number. I know retirement is not the most exciting or interesting topic in the financial world… or in any world, really. That doesn’t mean that it’s not important. In fact, that makes it seem even more important. The boring stuff usually is. I’ve found that the important/boring stuff is usually difficult as well, but that’s not the case with retirement. No, it’s not easy to master your investments and make millions, but the principles and information are available; you just have to take the time to educate yourself. Let’s see if we can get you started.
We’ll start with the basic principles and tools used to save for retirement.
- Save: Conventional wisdom is to just save as much as you can, but your general savings account isn’t for retirement. It doesn’t have the interest-earning potential to build up a large enough sum for your latter days. Continue to save in your bank account, but be sure to utilize other accounts specifically built for retirement. More on those below.
- Evaluate: You need to know how much money you’ll to need when you want to retire. You can get an idea by using our Retirement Fund Calculator. With some basic information and a goal in mind, it will tell you how much you need to save.
- Employers Can Help: If your employer offers a retirement plan, start contributing right away. Companies typically offer a 401(k) plan. It’s an investment that will grow exponentially over time. You tell your employer how much you want to contribute each month, and they make the deposit from your paycheck. This money is not taxed upon deposit, but it will be taxed when you withdraw upon retirement. Your company will likely have a limit to how much you can contribute. Also, the government limits how much you can put into a 401(k) each year. Many companies offer to match your contributions (up to a certain amount). Say they match up to 3%; If you contribute 3% of your salary to your 401(k), your employer will match that, giving you 6% total. That’s free money and it’s earning interest! Your employer makes the deposits, but you manage the investments. The money is invested into a mix of mutual funds, bonds, money market accounts, etc. You choose where the money goes. See your company HR manager to see what your employer offers.
- Independent Investing: There are options for people who do not have a plan with their employer. Popular examples are an IRA and Roth IRA. IRA stands for Individual Retirement Account. These are retirement plans offered by independent institutions that anyone can access (Fidelity, Vanguard, and T. Rowe Price, for example). There are eligibility requirements based on income and employment status. They operate similarly to the 401(k), but you’ll need to make deposits yourself, or set up automatic deposits. You also get to choose your own investments. Also, a Roth IRA taxes the money when you deposit, where as a 401(k) and traditional IRA charge tax when you withdraw the money. A Roth IRA also allows you to leave the money in the account for as long as you want. A traditional IRA requires you to begin withdrawing by age 70 and 1/2.
- Risk: All the aforementioned options work in the same way; they are investments that can go up or down. There is a level of risk, but you’ll find that certain investment options are riskier than others. It’s up to you to determine how risky you want to be, and you can change your investments at any time. For example, some people may make more risky investment choices when they are younger and have more time to recover should something go wrong. As they grow older, maybe they’ll switch to safer investments. The catch is that, usually, the higher risk investments offer the higher return.
- Penalties: All of the aforementioned plans are built to mature over a long period of time. You cannot withdraw any funds from these accounts until you are 59 and 1/2 years old. If you do, penalties will apply. However, there are exceptions if you retire at age 55 and leave the funds in the 401(k). Then you may make withdrawals penalty-free. This does not apply if you roll your 401(k) over into an IRA.
To optimize whatever retirement plan you choose, be sure to speak with a financial advisor who is qualified to discuss such matters. You can also educate yourself further by researching the investment options (mutual funds, bonds, money market accounts, etc.) to find out which is best for you.