Build Your Own Retirement Plan
Speros Financial
You may be wondering at what age you should start saving for
retirement. That’s a simple answer – as soon as possible. The moment you start
earning money you should think about saving for retirement. The earlier you
start, the less money you’ll need to contribute, thanks to power of
compounding.
Compounding allows you to earn more money on the money you invest as long as
you reinvest your earnings on that money.
So how do you get started? The first habit you need to
incorporate in your weekly budget is to pay yourself first. Then be sure you
take advantage of the free money from your employer if your company offers a
qualified retirement plan.
If you’re self-employed, you have different options to make saving for
retirement easier. If you’re employed with no employee retirement savings
options, then you can use a
traditional IRA,
but may want to consider a
Roth. If you change
jobs, be sure to take control of your savings by rolling them into an IRA.
Finally, start developing a vision of where you want to go and how you want to
live in the future.
Let’s take a closer look at these possible steps:
1. Pay Yourself First
Many people think of retirement savings as the money they
put away if there is any cash left at the end of the month. Generally when you
try to save that way, you tend to put away very little or nothing each month.
“Paying yourself first means saving before you do anything
else,” says David Blaylock, CFP, senior financial planner at LearnVest Planning
Services. “Try and set aside a certain portion of your income the day you get
paid before you spend any discretionary money. Most people wait and only save
what’s left over—that’s paying yourself last.”
Try putting aside just $10 a week (maybe bring two lunches
rather than eat out twice a week or skip a few trips to your favorite coffee
place). That may not sound like much but, thanks to monthly compounding, it
could grow surprisingly large.
Let's say you save $40 per month and invest that money at
4.65%, which is what the Vanguard Total Bond Market Index Fund earned over 10
years. Using an online savings calculator, an initial amount of $40, plus $40
per month for 30 years adds up to $31,550. Jack up the interest rate to 8.79%,
the average yield of the Vanguard Total Stock Market Index Fund over 10 years,
and the number rises to more than $70,000.
These sorts of funds aren't open to very small investors,
however. If you’re starting with just $40 a month, you won’t be able to
purchase these higher earning investments right away. You will need to start
with an IRA at your local bank. Most banks allow you to start an IRA using a
money market fund for as little as $100. You will need to build that fund to
savings level of $1,000 in order to buy into an IRA at most mutual fund
companies. At $40 per month or $480 per year, it would take about 2 ½ years to
save $1,000. Interest paid on that savings would likely be at only about 1%, so
your initial funding will come mostly from savings. One good fund that allows a
$1,000 minimum is the Vanguard Star Fund with an average return of 7.6% over
ten years. Once you have at least $3,000 in your IRA you can purchase the
Vanguard index funds mentioned above.
You can increase your savings as your income increases and
your nest egg can be a lot larger. Determine the investment mix that’s best for
you and use a savings calculator to see how fast your money can grow based on
the amount you can pay yourself first.
2. Get Your Free Money From Your Employer
If you who work for an employer that offers a retirement
savings option, be certain you take full advantage of any employer match for
that plan.
“If you are a typical salaried or hourly full-time employee
in the United States, you’ve probably heard about your
401(k) plan.
Fifty-two million Americans use them. Such plans held $3.5 trillion in
retirement assets at the end of 2012. Folks who work in educational
institutions have access to similar programs, known as
403(b) plans.
State employees use
457 plans. They all do the same thing: Give you free money,” writes Mitch
Tuchman.
The first part of the free money is that your contributions
are made with pre-tax dollars and lower your taxable income. Even better, many
employers offer to match your contributions to the retirement savings plan. For
example, an employer may contribute up to 6%, but that contribution is based on
you making the same contribution out of your paycheck. You don’t want to leave
that money on the table, so be sure to find out the details of your company’s
retirement savings plan and try to put in enough money to match that employer
guarantee.
If you can’t afford to contribute enough for the full
employer match, add to your percentage contribution each time you get a raise.
For example, if you were to get a 4% raise, increase your retirement savings
contribution by 1%. That way you still enjoy some increase in your pay, but pay
yourself first as well. Since contributions to these retirement saving plans
are tax-deferred, the actual amount of cash that will be taken out of your
raise will be less than 1% depending on your tax bracket.
3. Self-Employed Retirement Saving Options
If you’re self employed, you have many different types of
retirement savings options. These include a Solo 401(k), SEP IRA and Simple IRA.
The
Solo
401(k), also known as an Independent 401(k) is similar to the types of
401(k)s offered by employers. You can contribute money both as the employee and
employer. That allows you to save as much as $17,500 if you are under 50 or
$23,000 if you are 50 or older as the employee plus up to $52,000 as the
employer ($57,500 if you are 50 or older). You can only use this plan if you
are a sole proprietor. The only other employee you can have is your spouse.
The
SEP
IRA another option with similar contribution allowances, but it is simpler
to set up. This type of IRA can be used by small businesses with employees, but
the disadvantage can be that if you do decide to contribute, you must
contribute for all employees who are part of the plan.
The
Simple IRA is
this third option for small business people or people who are self-employed.
This, too, is easy to set up and operate but has lower contribution thresholds.
4. Traditional or Roth IRA
If none of the above options are available to you, start
your own IRA. There are two types – a traditional IRA, which lets you save tax-deferred,
and a Roth IRA, which you open with post-tax money. When you use a traditional
IRA, you can deduct the amount you contribute each year from your income, but
you will have to pay taxes on the money as you take it out. You pay taxes on
both your contributions and any gains earned while the money is invested.
Although the money you put into a Roth IRA is after-tax
cash, it means that when you take the money out at retirement, you don’t have
to pay any taxes – either on the money you originally contributed to the Roth
IRA or on the gains your money earned.
5. Keep Control of Your Retirement Funds
When you change jobs, you’ll need to decide what to do with
your employee retirement saving accounts. You’ll have the choice to cash them
out, leave them with the employer (if the employer allows this) or roll them
over into an IRA or, perhaps, into the 401(k) at your new job.
Rolling your employee retirement savings into an IRA is your
best option: “Rolling money into an IRA opens the toolbox, so to speak, for the
investor to invest in individual stocks, bonds – the whole range of investments
is now available," says Daniel Galli, a Norwell, Mass., certified
financial planner. With an IRA, you can choose how to invest the money, rather
than being limited by the choices in an employee plan.
As your savings build, you may want to get the help of a
financial advisor to determine the best way to apportion your funds. Some
companies even offer free or low-cost retirement planning advice as part of
their 401(k) programs.
6. Think About Life in Retirement
As you begin to establish financial goals for your future,
start imagining how you might want to live. Do you want to travel the world? Is
there a business you want to start or a second career you've dreamed of
exploring? Do you just want time to enjoy where you're living and get better at
golf – or help your kids. Saving for retirement before anything else will give
you the best chance of ending up with a nest egg that will enable you to
support your family and your life. Your goals will change, but they probably
won't be free. These changes don't have to wait until you hit 65 or 66. See
Peri-Retirement:
The New Life Transition.
The Bottom Line
Start saving for retirement as soon as you start earning
income, even if you can’t afford much at the beginning. Paying yourself first
is the most important habit you can develop if you want to enjoy a financially
healthy retirement.
The savings methods you choose will depend partly on what
your employer offers. But even if you are self-employed – or have no plans
offered by your employer – you still have good retirement savings choices.
Are You On Your Best Path To Retirement?
The average investor is doing just 5 of the 9 best practices
for growing their wealth.
How many are you doing? With FutureAdvisor, you can find
out in under 2 minutes. FutureAdvisor links to your investment accounts and
analyzes them as a single portfolio to give you
a holistic view of your investments. You’ll see what you
are doing well and where you can improve.
