Building Your Retirement Savings is Up to You
Saving for retirement is a key component of good financial health. Retirement savings are one of a few different types of savings you should build. All savings plans require you to choose set aside money that you could use for something else. You have to prioritize a future benefit over whatever pleasure you could get from spending the money.
Why You Should Save for Retirement
The main reason for you to save for retirement is that it is up to you to provide for your retirement. If you are like most workers, you don’t receive a pension from your employer. Social Security is part of the picture if you are retiring today and you hope it will still be there if you retire in the future. Social Security, however, is not enough to give you a comfortable lifestyle in retirement and it wasn’t intended to be your sole source of support after you retire.
The reality that building retirement savings are up to you can be scary, but it is also a good motivation to put aside money today. Don’t feel discouraged if you haven’t put money aside yet or haven't even given the matter much thought.
You are not alone if you have difficulty focusing on your future needs. It is easy to ignore needs that won't arise for years. It can be hard enough to stay on top of paying your bills each month and taking care of your basic needs, let alone put a plan in place for 30, 40, or more years down the road.
Psychological Benefits of Saving
It makes good financial sense to put money aside for your retirement, but there are other reasons to build retirement savings. For example, there are psychological benefits, too.
The money you put aside today provides financial security after you retire, but it pays immediate psychological dividends. You get some peace of mind from putting a solid plan in place, knowing that you are acting in your long-term interests. As saving for retirement becomes a habit, that feeling grows. When the topic of retirement comes up, your options aren't trying not to think or get depressed because you probably have to work the rest of your life. Instead, when you think about retirement, you can focus on how you will use your free time and enjoy your post-working years.
How Much Do You Need to Save?
The easy answer is a lot. The real answer is that there is no exact figure. In part, the amount you need to save depends on the costs that you will need to pay when you retire.
Here is one example: If you have a house that is paid off by the time you retire, your retirement funds need to cover your property taxes and home maintenance. If you are a renter or have a mortgage balance when you retire, your costs will be greater.
How much you need to save each month for retirement also depends on the lifestyle you want to support, how close you are to retirement, and if you have other income or assets to fund your retirement.
Whatever the amount that you want to have when you retire, it is true that the sooner you start building money in your retirement account the longer you will have to build up the funds, giving more time for the interest in your account to compound.
Let’s say you put $1,000 into a retirement account and then $100 every month. Assuming the interest on the account pays 5%, compounded monthly, after 40 years you would have $159,960.
What do you think you would have at the same monthly contribution and interest after 20 years?
It is a lot less than half of what you have after 40. In fact, you would have only $43,816.01. $43,8016 vs. $159,960 because you waited 20 years to start saving. By saving for 20 years, you end up with about 1/4 as much as saving for 40 years.
Understanding how much more money you will have when you retire if you start your retirement savings sooner, should be a strong motivator. Start now, if you haven’t already.
Retirement Savings vs. Other Important Goals
How highly you should prioritize funding your retirement is up to you. It can be confusing, especially if you are struggling. You may have high interest debt to pay off and no money in an emergency fund. Should you pay off all your debt before building an emergency fund? How much do you put in your emergency fund before the money is best put into a retirement account? Is paying for long-term disability insurance and life insurance more important than putting that money into your retirement account, if you have dependents who rely on your income for their support?
There is no one-size-fits-all answer to these questions. Your task is to make the choice that is right for you. It’s clear, however, that you can't let the confusion not stop you from making any choice at all. Start putting money towards any of the areas you think it makes sense, then work on a plan to define your financial goals for the short and long-term.
Retirement Savings Choices
When it comes to building savings for retirement, there are only a few major options available that are designed as retirement accounts with special advantages, if you don’t have a pension through their work.
401(k)- A 401(k) is the most common retirement plan offered by employers. 401(k)s make it easy to contribute and the easiest way is to have a set amount taken out of your paycheck automatically. The total amount you can contribute is set by law. In 2019, the maximum contribution is $19,000.
A big advantage of a 401(k) is that you don’t pay taxes on the money from your paycheck that you put into your 401(k), so your contributions reduce your taxable income. While you don’t pay taxes the year you earned it, your contribution is not tax-free. It is tax-deferred; the taxes are due when you take the money out.
Another benefit in many 401(k) plans is that your employer will match your contributions, up to a certain amount. Find out if your employer matches and take full advantage by putting enough into your account to get the maximum match offered. It is like free money.
The goal in putting money into your 401(k) is to not touch it until you retire. However, it is wise to pay attention to the rules your 401(k) has around withdrawing money before you retire. If your 401(k) doesn’t permit even hardship withdrawals, it could affect how much you decide to put into it or if you look for a different kind of retirement account.
If the company you work for doesn’t offer a 401(k) plan at all, then you will have to look at other retirement savings options.
IRA- An IRA (Individual Retirement Account) is another retirement account that offers you tax advantages over other ways of building savings. Like in a 401(k) the money that you deposit into a traditional IRA is tax-deferred. You don’t pay taxes the year that you earned the income, but when you take out the money.
The amount you can contribute into an IRA is set by law. In 2019, the maximum you can put in is $6,000, and is $7,000 if you are over 50. You can open an IRA as long as you are under 70 ½. IRAs offer a wide choice of investment options.
Roth IRA- A ROTH IRA is a specialized form of individual retirement account. Money you deposit in your Roth IRA doesn’t reduce your taxable income the year you deposit it. However, compared to a traditional IRA, the Roth IRA gives you the benefit of not paying taxes when you withdraw your contributions, and the growth on your investments in your Roth account are not subject to federal taxes.
Roth IRAs are not available to anyone who earns above a certain amount. For 2019, an individual can earn up to $122,000 and a married couple can earn up to $193,000.
In 401(k) plans and in IRAs, it is up to you to choose how the money is invested. 401(k) plans have fewer choices, but in any of these accounts you can choose to allocate your money at a risk level you feel comfortable and which makes sense for your age and individual financial situation.
A Piece of the Puzzle
When it comes to saving for retirement, it is important that you make a thoughtful decision. Weigh putting money aside for retirement against other needs. Building good financial health requires you to use your big-picture skills. You want to build retirement savings to have security in your old age. It is a crucial piece of your financial health, but it is one piece in the puzzle.
You may not be able to put as much away in your retirement account as you want for a very valid reason, such using your money to pay down high-interest debt or to pay for life insurance that protects your family from the financial harm they would suffer if you tragically died. If you have to make this kind of trade-off, that's OK. The key is being thoughtful in your planning, understanding the trade-offs you are making, and then readjusting your plan.