Saving for retirement might seem overwhelming, especially if you’re new to the workforce (what are all those acronyms, anyway?). This post will help you make sense of the alphabet soup and offer effective savings tips.
1. Start with a calculator
The first step toward a healthy nest egg is calculating how much you should be saving. This seems pretty basic, but according to research, people who punched their calculators saved more than those who didn’t. So, give it a go. There are many free online retirement calculators out there (a simple Google search will garner tons of results), though AARP’s is probably the best.
You should try to save as much as you can, taking into consideration your age, income and current living expenses.
2. Participate in a workplace retirement plan
Most companies offer a retirement plan, usually a 401(k) or 403(b). The plans are named after the section of the federal tax code that governs them. These two plans are very similar, however, the latter is used by non-profits, religious groups, schools and other organizations with smaller budgets. 403(b) plans are exempt from certain admin processes, so they are cheaper for companies to administer. This allows smaller organizations to still help employees save for retirement.
A workplace plan is the best way to save because the money is automatically deducted from your paycheck and put into your retirement pot. You live off whatever is left, and barely need to think about making payments. This ensures your retirement fund will grow steadily.
Related: How to tell if you have a lousy 401(k) plan
3. Take the match your employer offers
Nearly every employer-sponsored retirement plans offers matching funds—usually between 3-6% of what you contribute. You should always take your employer’s match. It’s free money and you should invest at least enough to get the full matching amount that your company pays to match your contributions.
Say your company offers a 3% match. This means that if you contribute 3% of your $50,000 salary, or $1,500, your company puts in another $1,500. You can add more than that $1,500 yourself, but the company won’t match beyond 3%.
However, formulas for matching funds vary, so talk to HR about how your company’s match plan is structured.
4. No workplace plan? Consider an IRA.
If your job doesn’t offer retirement, you should consider an individual retirement account (IRA). It’s a special type of savings account that helps you save for retirement and offers several tax benefits. Any person who has earned income is eligible for an IRA.
There are two types of IRAs: traditional and Roth. The essential difference between them is when you pay taxes. With a traditional IRA, you pay taxes on your retirement funds once you withdraw them (a/k/a retire). With a Roth IRA, you pay taxes as you go, so when you retire, Uncle Sam is already paid up.
Tax-free withdrawal is a powerful incentive, and it’s wise to invest at least some money in a Roth IRA in your lifetime. However, a traditional IRA might be necessary if you require a certain amount of money for living expenses each pay period.
Also, Roths typically have stricter contribution limits. This means that if you’re in a higher income bracket, you may not be able to contribute as much to your IRA as you wish. You also can’t deduct Roth IRA contributions, whereas you can deduct traditional IRA contributions.
Lastly, a traditional IRA requires you to make withdrawals at age 70½, but a Roth doesn’t.
5. Supplement your savings.
There are several ways to save for retirement savings beyond IRAs and 401(k)s.
Deferred compensation plans. Also known as 457 plans, deferred compensation plans are usually offered to state or local government employees. They are similar to 401(k)s, but you can withdraw money at any time without penalty (you only pay income tax). However, a 457 should supplement—not replace—a 401(k). Why? 457s have limited roll over options (so you might have to cash out if you leave your job) and limited matching plans.
Employee stock ownership programs. Some companies offer workers ESOPs, or shares of the company, usually for free. It’s essentially free money, so there’s no reason to turn it down. However, don’t count on ESOPs as your only source of retirement. ESOPs are subject to the stock market, and stock values can drop to zero if the company goes out of business.
What tips do you have for saving for retirement? Let me know in the comments section below.