Saving For Retirement Yet?
Savings, investing, and retirement are very related, yet the topic of retirement planning gets pushed off to the side.
We fear dealing with the unknown, or we are neglectful.
Instead, planning early and often for retirement will empower you to control a stage of life that could quite exciting if done right.
It is always an excellent time to start thinking about saving some long-term tax dollars.
Start As Early As Possible
You can start planning for retirement at any age, but the earlier, the better. Start in your 20s to take advantage of tax benefits, compounding interest, and peace of mind when you are older.
According to a 2017 study, 12% of Generation Zers are already saving for retirement. Another 35% of the participants plan to start saving in their 20s. Gen Zers, also called iGen and Post-Millennials, seemed to have gotten the strong message that controlling your destiny, including retirement planning, should be in your hands.
A Mini Case Study
As a college professor, I teach Gen Zers, but I learn so much from them. Recently, I opened up a discussion on marketing, lifestyle, and status with a question about how millionaires live.
Not surprisingly, many students volunteered with images of luxury cars, mansions, yachts, but one student yelled out, “They have lots of savings and invest more.” Suddenly, the class took a turn, and others shared how they had “put some money away” while another had opened a retirement account.
One of my quieter students hesitated and then forcefully shouted out, “Professor, I am 18 years. There is no *#!^$ way I am saving now for retirement !” A hush came over the room, some students giggled, and suddenly several students started sharing their thoughts about saving, investing, and starting early on retirement.
My students said that their parents hadn’t saved much “for anything.” The students wanted to do better for themselves by planning for retirement early. They intend to put money into their retirement accounts. They don’t think Social Security will be there for them.
I always recommend books to my students and offer points toward their grades if they write a short essay. They seemed eager for points, so I suggested: The Millionaire Next Door: The Surprising Secrets of America’s Wealthy: Thomas J. Stanley, William D. Danko. If you haven’t yet read this book, it identifies the key traits of those who accumulate wealth by emphasizing that putting away money for your future is paramount.
A surprising number of my students have taken up the offer, read the book, and submitted an essay for their extra points.
Why You Need Retirement Planning Early
- Life expectancy has increased significantly since 1960. Recent forecasts point to further increases to 83-86 years for men and 89-94 years for women in 2050. Assuming you retire at 65-66 years, you will need 20 years of savings at a minimum.
- There could be challenges for Social Security retirement income benefits. About 65 million, or nine out of ten Americans, aged 65 or older received $1 trillion in social security benefits in 2020. These income benefits represent 33% of the income of the elderly.
- Defined pension benefits have a long history but were a 20th-century cornerstone for retirees. A defined benefit pension plan promises a specified pension payment or a lump sum payment from your employer when you retire. It is a particularly desirable compensation perk but declining in use, like rotary phones (a now antiquated way to dial a telephone). Today, only 4% of private-sector workers participate in pensions, significantly declining from 60% in 1980.
Retirement Goals You Should Consider
- Start saving early in a retirement account, even if initially in small amounts.
- Raise your contributions accounts as you receive salary boosts and bonuses.
- Put up enough dollars to earn your employer’s match.
- Aim to contribute up to the limit allowed for your 401K employer-sponsored 401K and your Roth IRA plans.
- Borrow from retirement accounts only as a last resort.
Retirement Accounts are Really Investment, Not Savings Accounts
By saving early in your retirement, you are investing for the long term. Through the benefit and magic of compounding, you can have substantial funds by contributions, even if you begin with a relatively small amount in your 20s.
For example, Emily is 35 years old and puts 6% or $4,200 of her annual salary into the plan. Her account balance would be $279,044 with a 5% yearly return and 30 years until she retires at age 65. That amount would jump to $397,000 if she opted for a more aggressive fund at a 7% return along with higher risk. These amounts do not reflect an employer’s potential matching contribution.
Have Tax Advantages
There are different retirement accounts, but they have a few things in common: they have tax advantages with varying growth scenarios depending on your preference. They have contribution limits set by the IRS that have increased over the years.
The best known of all retirement plans is the traditional 401K. They have primarily replaced the defined pension benefit plans.
Most, but not all, employers provide the 401K plans for recruitment and retention purposes.
Small companies, which typically have resisted offering these plans because of cost concerns, often have many part-time or contract employees. They have been slower to adopt these plans and can choose to provide SIMPLE 401 K (see below).
Varying 401K Plans
If you consider employment between two companies, examine the competing offers based on their sponsored plans for employer matching of your contribution.
Typically, a company will match 50% of every dollar you annually up to a percentage of your gross income, usually around 6%. Some companies match on a dollar to dollar basis but at a low rate of your salary.
Your contributions are on pretax dollars up to $19,500 in 2021, with an additional $6,500 contribution allowed if you are over 50 years as a catch-up measure.
Using pre-tax dollars, defer your federal and state taxes paid upon withdrawal, beginning age 59.5 years. Withdraws before that time will usually result in a 10% penalty. If you are retired, you must begin withdrawing required minimum amounts (RMDs) by age 70.5 years.
Greater Participation In Retirement Plans Can Happen
About 70% of all US workers have access to employer-sponsored plans, including 401K, 403b, 457, and the federal government’s Thrift Savings; 55% are participants. As more companies offer automation of contributions directly from paychecks, more employees will likely participate.
If your company offers a 401K plan and will give you some kind of employer match contribution to add to your own, you are robbing yourself of that gift, and the compounding benefits for the many years you have until retirement. You are just leaving money on the table!
Surveys have indicated that some employees say they don’t participate in their employers’ 401 K plans because they get overwhelmed by the possible choices they have and then postpone signing up for the program. Employers have encouraged employee participation by providing more information about investment choices and transitioning to opt-out offerings, rather than opt-in.
You can make changes in your selections if you think you picked a too aggressive or too conservative investing approach. Pick one and read your statements, familiarize yourself with the other choices if you want to make a change. Just make sure you start your plan and put in enough to qualify for and trigger your employer’s contribution.
Roth 401K is similar to the traditional 401K but uses already taxed dollars, so your withdrawals are tax-free. Roth 401K’s began in the retirement lexicon in 2006 after the introduction of Roth IRA.
Other 400 Plans For Different Organizations
403(b) plans are for employees of non-profit organizations.
The 457 plans are for state, local government employees, nonchurch, and other tax-exempt organizations. No employer contributions are allowed for this plan.
Employers with 100 or fewer employees offer Savings Incentive Match Plan for Employees or SIMPLE 401 K. Employers must choose between making matching contributions up to 3% of each employee’s pay or nonelective contributions of 2% of employee’s pay.
If you don’t have access to a 401K plan, or even if you do, you can personally set up your retirement account with a traditional IRA or a Roth IRA.
Your contribution to a traditional IRA is in pretax dollars. You defer tax payments until you make withdrawals at age 59.5. If you take out money from your IRA before age 59.5, you will pay taxes and may trigger a 10% penalty plus tax. You may contribute $6,000 in 2021, or $7,000 if you age 50 or older.
IRA withdrawals begin at age 70.5 as required minimum distributions or RMD.
The logic behind paying taxes at an older age is that you may be in a lower tax bracket. However, the reason may be in reverse, and that’s why Roth IRA’s have increased in popularity. Of course, your tax brackets will reflect how well you do in your career, and it is not likely you know that in your 20s.
With Roth IRAs, you contribute after-tax dollars, and your money grows tax-free. Your withdrawals are tax-free after 59.5 years.
Roth IRAs have no required minimum distributions like their older IRA counterpart. You may be able to withdraw your contributions, not your earnings, before age 59.5 years without penalty if your Roth IRA has existed for five years or more.
In many ways, Roth IRA has been the preferred vehicle for personal retirement accounts and are more tax-friendly longer term.
Arming yourself with both 401K and IRA retirement accounts is the minimum planning you can do when you are in your 20s and 30s.
Borrowing Money From Your Retirement Savings Is The Last Resort
There are times when you face financial hardship and consider borrowing from your retirement plan. Your 401K plan (not your IRA plan) allows you to borrow from your retirement assets and repay the amount with interest to your account rather than to a financial institution.
One of the most significant drawbacks of using your retirement assets is the loss of tax-deferred compound growth for the loan duration. Taking assets out of a retirement account should be a last resort. We discussed withdrawals, and if you do so too early, you pay taxes and penalties.
You have long years in front of you. Even with small amounts, starting early in your planning allows you to benefit from compounding growth through the years. Earning interest on interest adds significantly to your retirement fund.
Do it early so you can avoid the real angst of not planning. Procrastination is not an answer to anything! You’ll be glad you are getting a headstart!
Thank you for reading!
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.