Getting Started with your Retirement
No matter your age you should be giving some thought to your retirement. I promise it does not need to be scary or complicated. Truly it can be as simple and easy as you want it to be and if you haven't’ started saving for retirement, there is no better time than now.
The topic of retirement could fill an entire book, but this article is intended to cover the basics. There is a fair amount of information in this article, so check the topic headings if you want to skip around to specific info.
Topics
How much will you need in retirement?
How much of my paycheck should I allocate to retirement?
Types of retirement accounts
Where can you open an IRA?
What to invest in for your retirement account?
Key Points
Start saving for retirement as early as you can. A little bit can go a long way.
Be consistent. Contribute weekly or monthly.
Use tax advantaged retirement accounts when possible.
How much will you need in retirement?
A very important first question that will help you answer other retirement questions later on. In order to determine how much you need to save every month to be your retirement goal, you’ll need to estimate how much money you’ll need to save to last through your retirement.
An easy rule of thumb to start with is the “multiply by 25”. All you do is take the amount of income you would like to have each year in retirement and multiply it 25. For example, if you feel like $2,000 per month or $24,000 per year seems reasonable, then you would multiply $48,000 by 25 to get $600k. If you’re not sure what annual amount to use, think about how much you make per year and how well that works with your annual expenses. Or you can total up your annual expenses and add some extra as a buffer. The problem with this “rule” is that it greatly over simplifies and doesn’t take into account specific variables. It’s fine as a starting point, but use a retirement calculator when you have more time to run a more complete analysis.
There are plenty of easy to use online retirement calculators that can help you with this. Since these are estimates based on many assumptions (life expectancy, retirement age, annualized investment return etc.) it is helpful to play with the variables to see what range of outcomes you have.
For example, see what happens when you change your retirement age from 55 years to 65 or 70 years old.
Or adjust your invested rate of return. The S&P has averaged about 10% per year in returns so you shouldn’t assume returns greater than that. 5% is a reasonable lower estimate to use.
No matter what, be realistic with your assumptions. It won’t hurt to lean on the safe side when doing the analysis.
Create a low/ high range based on your best guess assumption, as well as a conservative estimate. Your conservative estimate might increase your life expectancy and reduce your expected investment returns to give you a higher retirement amount needed.
There are several investment vehicles to help you with your retirement. The main benefit of these accounts tends to be that they are tax advantaged in one shape or form, meaning they can help reduce your tax burden when you decide to take out distributions at retirement. It’s also worth noting that if you pull money out early (usually 59 ½ years old) you will be subject to a 10% penalty in addition to any taxes you would otherwise owe.
How much of my paycheck should I allocate to retirement?
Of course, this depends entirely on how much you plan to need at the start of your retirement, as well as how much time to have until your estimated until retirement. However, another quick rule of thumb to get you started is to set aside 10% to 20% of your income to retirement. You may need to adjust these, as you will be subject to the annual limits noted below. A common mistake I hear when I talk with people of all ages is that they contribute maybe 5% or less to their retirement. Usually they don’t have a great reason other than they want their take home pay check to be bigger. Now if you really need the money to pay for important living expenses, that’s acceptable. Otherwise you’ll want to bump that number up.
To get an idea of what saving $500 per month might get you, let’s run through some hypothetical examples. We’ll assume 3 people of different starting ages (25, 35 and 45 years old) with no savings, a retirement age of 65 and an expected annualized investment return of 8%. Based on this we get the following amounts saved at retirement:
25 year old (40 years of saving for retirement)
$1.5 million
35 year old (30 years of saving for retirement)
$680,000
45 year old (20 years of saving for retirement)
$275,000
As you can see, early starts can make a huge difference.
Types of retirement accounts
Now let’s hit the main points for 4 common types of retirement accounts. Note that depending on your situation, you may only be eligible for certain plans. Note that contribution limits are often updated slightly each year.
401(k) A common employer sponsored retirement plan for the private sector.
Contribution limits: $19,500 or $26,000 if you're 50 or older.
457(b) Think of this as a 401(k) for government employees.
Contribution limits: $19,500 or $26,000 if you're 50 or older.
403(b) Think of this as a 401(k) for not-for -profit employees.
Contribution limits: $19,500 or $26,000 if you're 50 or older.
IRA or Individual Retirement Account
Contribution limits: $6,000 or $7,000 if you're 50 or older.
It’s also worth noting that each of these retirement accounts can have Traditional and/ or Roth options available. Here’s the difference:
Traditional is “pretax”, meaning the contributions lower your taxable income and reduce your tax burden now. At retirement, when you start to withdraw the funds they will be taxed as ordinary income.
Roth is “after tax”, meaning that you are taxed on the contribution now, but are able to pull it out tax free at retirement.
Since tax rates change and we can’t predict the future, it doesn’t hurt to have both, but allocate more to the one that is more useful at the time. For example, let's say you’re early on in your career, you might allocate 75% to your Roth and 25% to your Traditional account.
In both cases the money grows tax free, hence why people use them over investing in non-retirement accounts. If you are eligible for an employer sponsored retirement plan like the 401(k), 457(b) or 403(b) there are typically no restrictions on the Roth. However, Roth IRAs do have income limits of $139,000 for single tax filers and $206,000 for joint tax filers.
Is a Traditional or Roth plan better for you? . The general idea is that earlier in your career, when you are typically earning less, lean more towards a Roth since your tax rate will tend to be lower. Later on in your career, when you tend to have higher earnings, thus higher taxes, lean more towards Traditional so you can lower your tax bill.
Where can you open an IRA?
If you don’t have the option of one of the employer sponsored retirement plans, or just want to be able to contribute more to your retirement, you can always open an IRA with many brokerages like Fidelity, Vanguard and Schwab, there are also robo-advisors that have an IRA option. Axos Invest and M1 Finance are good robo-advisor choices to help automate your saving. See our M1 review here and click here for a M1 referral to earn money when you sign up for M1.
What to invest in for your retirement account?
Now that you have an idea of how much you need to save for retirement, what should you invest in? Naturally, the answer depends on many factors. Here are some questions to ask yourself:
What’s your tolerance for investment risk?
How long until you retire?
In general the more time you have until your retirement the more investment risk you can assume. The thought process is that over long time frames (usually more than 10 years) you have the ability to absorb and recover from market volatility. This means that earlier in your career you might hold a larger percentage of diversified stocks in your portfolio and as you get closer to retirement your account will increase the amount of bonds you have to reduce the likelihood of a large drawdown in your portfolio.
Here are some very simplified examples:
An early career saver may invest in 80% stocks and 20% bonds (80/20).
A mid career individual may have a slightly more conservative approach with something between 80/20 and 50% stocks / 50% bonds (50/50).
Late career or in retirement would likely be even more conservative to reduce their exposure to market volatility. Possibly something between 50/50 and a 25% stocks and 75% bonds.
We have compiled a series of easy to follow portfolios that may be helpful in determining what you should invest in. See the portfolios here. We also have an article on general investing you may find helpful.
Final thoughts
It goes without saying that saving for your retirement is very important, but it doesn’t need to be difficult. A great approach for many people is to automate as much as possible. Most employer sponsored retirement plans do this by default. If you have an IRA set up recurring deposits or use a robo-advisor to do most of the heavy lighting for you. The next step is to make sure you are contributing a reasonable amount so you can reach your retirement goals.
Retirement accounts aren’t the only way to save for retirement, but the tax advantages are worth taking advantage of as much as possible. Other than that start saving as early as you can, contribute consistently and check in periodically to track your progress to see if you need to make adjustments. Financial advisors can help with your specific situation.