When you’re young, it’s sometimes hard to make decisions that sacrifice the present for something 40 years away. It’s human nature to lean toward instant gratification than satisfying a need in a future that is far away. Saving for retirement is crucial for all of us, especially since Social Security may or may not be around in 20 years. So how do we get started? With all the savings mediums available to us, how do we know what to choose to make good use of our money? Every situation is different, and I recommend you to discuss your retirement plan with a certified financial adviser (preferably one that does not gain commissions from you) to really align your choices with your long-term goals and needs. In the meantime, here is a very basic guideline to use to start your retirement savings.
- Maximize your company match
- Maximize your Roth IRA (if eligible)
- Maximize your 401(k)
- Make after-tax contributions to your 401(k)
Maximize your company match
Hopefully your employer has some sort of 401(k) matching plan that you can take advantage of. If so, it’s a no-brainer. Not taking advantage of company sponsored retirement matching is basically throwing away free money. Most companies offer a match of up to 3% of the first 6% contributed by the employee (so basically 50 cents to every dollar you put in up to 6%). With some employers you may get even more. I have seen employers that are offering 8-10% dollar for dollar matching on 401(k)s! That is outstanding, and overall a great way to start off your retirement savings.
Maximize your Roth IRA (if eligible)
Once you are maximizing your company match, you want to set up a Roth IRA for yourself. Roth IRAs are great because they allow you to put after-tax income into an IRA, and when you retire and make a qualified distribution, you will get your interest gains tax free! The Roth also has the added benefit of you being able to withdraw your after-tax contributions at any time without penalty, so it can double as an emergency savings if need be. Roth IRAs do have some stipulations though. For instance, there is a limit on how much money you can put into a Roth IRA on an annual basis. For 2008, the annual limit is $5,000 ($6,000 for 50 and over).
Another limit with the Roth is that not everyone is eligible to contribute. Eligibility is based on income, and phase-out rules apply. For single tax filers the phase-out rules begin at a gross income of $99,000 and eligibility is taken away at $114,000. For married filers, it’s $156,000 and $166,000 respectively.
The Roth IRA is as close to a slam dunk as you’ll find, so you should contribute the maximum to it every year you are eligible.
Maximize your 401(k)
Alright, now we’re rolling. After maxing out your company match and your Roth IRA, it’s a good idea to put more of your money into your 401(k) until you maximize your contribution for the year. Currently the max you can contribute to a 401(k) is $15,500 ($20,500 for 50 and over), and this does not include your company match. Maxing out your 401(k) also gives you the added benefit of bringing down your income for the year, so you get a little more tax savings up front.
Some employers are now offering a Roth 401(k) option, which combines some of the characteristics of the 401(k) and of the Roth IRA. This is a very interesting option depending on your financial and tax situations and definitely something you should look into to determine how beneficial it can be to you.
Make after-tax contributions to your 401(k)
If you are able to get this far, you’re doing a fantastic job of saving for your retirement. For most people, you probably wouldn’t need to go farther to have a nice normal retirement. However, if you plan to retire early, or plan to live a more expensive lifestyle after retirement, then you should consider making after-tax contributions to your 401(k) account. After-tax contributions allow you receive any after-tax withdrawals from your contributions tax free, but any gains from after-tax contributions would be taxed at the time of withdrawal. While the tax implications aren’t as advantageous as the other contributions, it’s just one more way to save money for retirement.
This is a good basic retirement plan that can help you get started saving for your future. Remember, the younger you start, the better off you will be. I didn’t have the luxury (or the knowledge) to get started until my late twenties, so if you’re able to do that you should be in great financial shape with possibly an option of retiring much earlier than the traditional retirement age of 65. Make sure to go over your retirement goals and try to align your financial decisions to those goals you choose, so that you can live the life you expect to live after you stop working.
