My last post, focused on taking advantage of employer sponsored retirement plans (401(k), 403(b) etc). It didn’t explore what to invest in or how to spread your investments among several asset classes, but rather on the basic act of actually saving. That is, getting in the habit of repetitively setting aside income today for use in the future; your financial future.
Employer sponsored plans make it relatively easy to save. Most now automatically enroll employees forcing them to intentionally decide not to participate by opting out within 30 days or so. Very few employees actually take the time to opt out which, in my opinion, is a good thing.
So, what if you don’t have a plan at work that you can use? Do you just wait until your employer adds one? Figure that you’ll contribute in a few years when you switch jobs to a new employer that does offer a plan? Well the answer to those questions is: Absolutely not!
Create your own retirement plan by using an Individual Retirement Account (an IRA). IRAs can be incredibly flexible. You aren’t just limited to just one provider like a 401(k). There are lots of low cost providers out there like Fidelity and Vanguard that make setting up an IRA account online fairly easy and straightforward.
By the way, while I’ll focus on using an IRA in this post, the information below can also be used to set up a regular investment account too. I think it’s important to save in multiple types of accounts (taxable, tax-deferred, tax free) to provide maximum flexibility in retirement with regard to tax withdrawal strategies.
Sometimes, there is a low investment minimum ($1,000 or $3,000) that’s required to establish the account, but you can simply save the amount in your checking or savings account until you have enough and then transfer the money over. Often, you can set up the account if you agree to have money debited from your bank account on a regular basis (ie. monthly) and avoid the minimum investment amount.
If you don’t have the discipline to be able to reserve the monthly debit from your checking account, then I would strongly suggest setting up a separate bank account just for this purpose. An account that you leave the debit card or checkbook safely stored away somewhere so you’re not tempted to use the funds for anything else.
Better yet, after setting up your separate bank account, visit your payroll department at work and create a direct deposit to fund this separate account. After you determine how much you’d like to contribute to your IRA each year, divide the amount by the number of paychecks your receive annually and then round that amount up slightly. That way you’ll have a little extra reserved. For instance, say you want to contribute $2,000 to your IRA each calendar year and you’re paid every 2 weeks. Instead of depositing $76.92 each pay period ($2,000/26), round up to $85 per pay period. You’ll not only have the monthly amount to transfer to your IRA but a little extra to build up.
Why the extra? Well, you’re on your own with the IRA. Unlike a 401(k) which automatically increases when you get a raise (and if you’re lucky enough to have automatic contribution increases each year), you’ll need to go back each year and increase both the transfer amount to the IRA and to your direct deposit account. Consider the chart below which demonstrates why you’ll want to increase your contributions each year.
Using similar assumptions as in my previous post, the chart on the left shows an ending balance of over $606k when you increase your contributions each year by 3%.* Note the amount of the increase between age 25 and 26 is only $60 or $5 a month… not a whole lot, but the results over time can be amazing. In this case, it’s nearly a $200k difference in a retirement nest egg!
Let’s not forget that you’ll also receive a tax benefit if your contributions are made to a Traditional IRA. While the 401(k) has the immediate tax benefit in your paycheck, you’ll need to deduct your Traditional IRA contributions on your tax return. Same benefit, just received a little differently.
If single or married and neither you or your spouse are covered by employer sponsored plan then your contributions (up to $6,000 in 2019 or $7,000 if age 50 or older) are fully deductible. If single, or married and your spouse is covered by an employer sponsored retirement plan then, depending on your income, your deductions may be limited. The rules can be complex so make sure you speak with a qualified tax advisor. If you’d like to get the details, below are two links to the IRS website that can be helpful:
Similar to my thoughts on investment selection for a 401(k), don’t let the investment decision for your IRA stop you from getting started. A target date fund is an appropriate first choice if you’re new to investing. Once you get going, you can spend some time reading and learning about investment choices and create an investment portfolio that meets your individual needs.
Saving a set amount on a regular basis, whether in an employer sponsored retirement plan or in your own IRA, is a fantastic way to get the ball rolling toward a more financially secure future. It’s the repetitive process of setting aside funds as you are paid that sets the stage for building wealth in the long run.
In the next post, I’ll give you some thoughts on Health Savings Accounts and how they can be used for your future retirement needs. If you’ve set up a systematic savings plan for an IRA or a regular investment account, what are the tricks you’ve used to make it easy? Would love to hear your thoughts.
Thanks for stopping by.
*The chart on the left assumes a 7% growth rate for the 40 years and the contribution amount is increased by 3% each year. The chart on the right assumes a 7% growth rate for the 40 years and level contributions each year.