If you’re on my email list, you may remember that post that I promised you last week – the one where my friend and financial planner was going to guest post and share all the details of saving for retirement? Well…..here it is! Natalie is going to share with you, step-by-step how to save for retirement!
Saving for retirement can seem really overwhelming.
But you can learn the basics at a very high level and make it easier. Doing it this way will help you conceptualize where to start and which direction to head.
In this post, I’m talking about how to start saving for retirement – meaning, the steps you should go through at the very beginning to know which plan to use and what to do in that plan.
You may be wondering what makes me qualified for this! I’m a former lawyer turned financial planner and blogger. I’ve passed the CFP® examination, and I work at a registered investment advisory firm as my day job. All that is to say, I’ve had a bit of experience with helping people save for retirement.
So, now that you know where I’m coming from, let’s get down to business…
The information below is general information to help you better understand where to start saving for retirement. The more you know about this stuff, the better off you’ll be financially.
Let’s get started!
PHASE 1: UNDERSTAND WHICH PLANS YOU CAN USE
In the first half of this post, I am going to explain the types of retirement plans you can use.
Unfortunately, you can’t invest in any or every retirement plan out there.
Depending on your employment status and the type of employer you have, you will be limited where you can save for retirement. Your income is also a factor that limits which retirement accounts you can invest in.
Go through the steps below to determine which retirement plans you can contribute to.
Step 1: Employment status
The type of plan that you can contribute to depends on whether you’re self-employed or whether you work for an employer.
If you’re self-employed, go to Step 2 now (and skip Step 3).
If you’re an employee (and work for an employer) go to Step 3 (skip Step 2).
Once you’re done with Step 2 or 3, then regardless of your employment status, go to Step 4.
Step 2: Retirement plans available to self-employed people
If you’re self-employed, you can open retirement plan specifically for self-employed people. This is because you don’t have access to an employer’s retirement plan (like a 401(k)).
Here are basic options for self-employment people:
- Individual 401k plan (i401k or Solo 401k)
- Simplified Employee Pension plan (SEP IRA)
- Savings Incentive Match Plan for Employees (SIMPLE IRA)
- Other Defined Benefit Plans (opened less frequently nowadays, so I’m not going to talk about them here).
As a self-employed person, you can open one of the retirement plans above. Which plan you choose depends on a variety of things. Visit my post on retirement plans for self-employed people to help understand these plans in more detail. An accountant or financial planner would be a great help in determining which plan is best for you. It’s a lot to undertake yourself if you’re self-employed and not experienced with this stuff. Another good resource is the IRS page on retirement plans for self-employed people.
Whatever you do decide on will be your own self-employed retirement plan. This is one retirement account. But there’s more. You can have another retirement account in addition to this one.
Head on over to Step 4 to for the next retirement plan you can use.
Step 3: Retirement plans available to employees
If you’re an employee, there is a good chance your employer will have an employer-sponsored retirement plan. To find out which retirement plan(s) your employer offers, ask the HR department.
Here are some of plans your employer may offer, depending on what type of entity it is:
- 401(k) or Roth 401(k)
- Stock bonus plans
The plans listed above all fall into the category of “defined contribution” plans. There is another category called “defined benefit” plans. This includes plans like pension plans. Ask your HR department which plans your employer offers to learn more about these plans.
Once you know which plans your employer offer, you need to talk with your employer to set up your plan. This plan will go through whatever company houses the employer-sponsored plan.
There are specific limits on how much you can contribute to in certain plans. For example, in 2017, if you are under 50 years old and contributing to a 401(k), your maximum annual contribution is $18,000 (if you’re over 50, it’s $24,000). Look through the plan documents to determine what your contribution limits are.
One important thing to consider is whether your employer offers a match. Generally, you don’t want to leave “free money” on the table. So, if your employer will match your contributions, look into contributing to that retirement plan at least up to the match.
Once you have explored and/or opened a retirement-sponsored plan, then you can more on to Step 4.
Step 4: Retirement plans for everyone – regardless of your employment status
You can also contribute to a retirement plan at a brokerage firm in addition to your employer or self-employed plan. You will need to open and manage this account yourself (unless you have a financial advisor who does it for you).
In general, there are two main options: a traditional IRA and a Roth IRA.
- Traditional IRA. A traditional IRA is a retirement account that you contribute to with pre-tax dollars, making it a potentially great tax-advantageous vehicle if you are eligible to take the deduction (but not everyone is). Generally, your money will be taxed in retirement, when you take distributions from your IRA (both your contributions and earnings will be taxed). There are certain contribution limits to IRAs. In 2017, if you are under 50, you can contribute up to $5,500 annually ($6,500 if you’re over 50).
- Roth IRA. A Roth IRA is the same vehicle as a traditional IRA, except certain rules apply. You can only contribute to a Roth IRA if your income is below certain limits. If your income is above those limits, you have to use a traditional IRA. Roth IRA contributions are never tax deductible, but you’re not taxed on the money when you withdraw it in retirement (which is amazing).
Combining one of these plans with an employer (or self-employed) plan, is a great way to get maximum retirement savings.
For example, let’s say you have a Roth 401(k) and a Roth IRA and you’re under 50 years old. You can potentially contribute up to $18,000 to your Roth 401(k) and an additional $5,500 to your Roth IRA, annually. This is a ton of annual retirement savings every year!
The combinations of accounts are extensive because what you are eligible to contribute to depends on a lot of variables. The key take away is to know that you can invest in an individual retirement account – either a Roth IRA or traditional IRA. After you’re done with this post, learn which you are eligible for and decide if it’s right for you.
PHASE 2: DECIDE WHAT TO INVEST IN
Phase 1 was about learning which accounts are available for you to contribute to. Phase 2 is about knowing what to do once you have the accounts open (specifically, what to invest in).
The best way to go about this is to either:
- Hire a financial planner (and if you do, read these questions to ask your planner before hiring her), or
- Teach yourself about investing.
I can’t teach you everything there is to know about investing in this post. But I can give you a few pointers.
My first pointer is to think of your retirement accounts – all of them combined – as one investment portfolio (in addition to any other investment accounts you have). This means that you should consider all your accounts together when you choose how you want to invest.
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For example, let’s say you have a 401(k) and a traditional IRA. Think of these accounts as part of one pie. The one pie is your portfolio. Then, you decide to cut the pie into different sized pieces. These pieces are asset classes. Let’s say you decide on 3 different asset classes – equities, bonds, and market diversifiers. You can split up these classes among the whole pie so they’re divided how you want. You don’t need to put all three asset classes in the 401(k) and the IRA (but you can).
You do need to make sure they’re somewhere in your whole portfolio. So, let’s say your 401(k) doesn’t have the best investment options available and you only want to invest in equities and bonds in your 401(k). You can make sure your IRA has more market diversifiers in it to make up for the fact that you don’t have any in your 401(k). This way of thinking focuses on your portfolio as a whole.
My second pointer is to learn about asset allocation. Ramit Sethi explains the important of asset allocation when he says “[y]our Investment plan is more important than your actual investments,” in his book “I Will Teach You To Be Rich”. He’s talking about asset allocation when he says “your investment plan.” Asset allocation is the investment strategy you decide on for your investments.
It’s how you decide to allocate your investments across different asset classes, such as stocks, bonds, money market securities, real estate, etc. The goal of asset allocation is to minimize risk and maximize return across your entire investment portfolio. Which asset allocation is right for you depends on a lot of factors, including your age, time horizon, and other family circumstances. To decide which asset allocation to use in your portfolio, spend time learning about investing or hire a professional.
My final pointer is to understand the total fees you’re paying. You may or may not know that there are fees when you invest and save for retirement. Here’s a post that lists the types of fees you can potentially pay. The lower the fees, the better. The hard part is figuring out exactly what you’re paying in fees.
You can pay a fee on each of your accounts. You can pay a fee when you trade within your account. You can pay enormous fees as a percentage of your portfolio that you could have no idea about because they’re hidden so well. Over time, your fees can have a huge impact on the money you save for retirement. So, do your research and figure out exactly what you’re paying in fees. It’s too important not to.
Resources I love for learning how to create an investment portfolio and save for retirement yourself are:
A FINAL NOTE!
There’s no doubt that learning how to save for retirement can seem overwhelming at first. That’s the bad news. But the good news is the more you learn, the easier it gets.
I recommend starting with spending 20 mins a day (at lunch or before bed, for example) reading about how to save for retirement. This will give you more background and knowledge, which will result in more confidence in your retirement saving abilities.
I’m a firm believer that no one will care more about your money than you will, so take the time and spend the energy learning about it now. You’ll never have more time than you do right now to start!
ABOUT THE AUTHOR:
Natalie is a financial planner, blogger, and recovering attorney. Natalie blogs at NatalieBacon.com where she writes about money, career, personal development, and blogging.
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