Retirement may seem like a million years away, but it'll catch up to you quicker than you expect (just ask your grandparents). If you can see the decades until retirement as an opportunity, rather than a reason to procrastinate, your future self will thank you. Those opportunities reap sweeter rewards if you act on them today, so you should get your retirement plan together ASAP. Here are a few of the most popular ways to save for retirement, and some strategies to get the most out of your money.
Even if you're brand new to retirement planning you probably know about 401(k) plans. The employer-sponsored programs make it easy to invest and minimize your tax liability, especially if you can get started young. The investment portfolios are carefully designed to start out risky and gradually become more conservative as you approach retirement age. There are lots of 401(k) plans out there, but they all fall into one of these categories:
This is the baseline of 401(k) plans. Your employer gets a tax benefit for offering to match your contributions, and you'll get to write off your contributions during tax season. You should be contributing as much as your employer will match. If you aren't maximizing your employer's contributions you're leaving money on the table. It's also important to wait until you're about 60 (59 ½ in most cases) to start spending the money. Otherwise, you'll pay a tax penalty on the withdrawal, which can defeat the purpose of saving in a 401(k) in the first place.
Some employers offer this type of 401(k), based in part on a Roth IRA plan. It reverses the tax incentive of a traditional 401(k), which gives you tax breaks upfront and takes taxes out when you make a withdrawal. Instead, you'll pay taxes on the money you put into a Roth 401(k), but you'll minimize – or eliminate – income and capital gains taxes for the money you take out. If you have a Roth 401(k) pump in as much money as you can, as quickly as you can. That way you can maximize your return on investments (which will be tax-deferred or tax-free).
This is a 401(k) for self-employed people who don't have any employees (there is an exception for spouses). It's a good way for freelancers and small business owners to put away pre-tax dollars for retirement. These plans are relatively new. Until recently, self-employed workers usually opted for an IRA plan, but if you earn less than a quarter million dollars every year, and want to maximize your retirement contributions, you may prefer the Solo 401(k)'s tax benefits.
An individual retirement account, or IRA, is similar to a 401(k), except it has nothing to do with employers. An individual opens the account directly with a financial institution, giving that person much greater control over how to invest their money. It also offers a whole different set of tax benefits. Here are two of the most common types of IRA:
These retirement plans are a way of supplementing or replacing 401(k) plans, and they work in a similar way. Contributions are tax-deductible (up to a certain amount every year), which makes traditional IRAs good for people who want to maximize their annual tax returns. Unlike 401(k)s, you will play a larger role in choosing your investments. If you're new to investing, you should stick mostly with mutual funds and ETFs (Exchange-Traded Funds), which are compiled and managed by experts. You'll also have to balance your portfolio based on your risk tolerance. Bonds are considered the safest thing next to cash. Stocks are riskier. Their value fluctuates between extreme highs and lows, but over time they usually make you more money.
A Roth IRA has fewer restrictions than a traditional IRA, but you won't qualify for one if you're making more than $137,000. Roth accounts are more forgiving about early withdrawals, so you won't pay huge tax penalties for taking out some of your money before retirement. If you're worried you may have periods of financial instability in the future, but still want to start saving, a Roth IRA might give you the peace of mind you're looking for. That's in part because you can only put after-tax dollars into a Roth account, which means you won't get any tax benefits upfront.
Health Savings Account
Health plans and retirement plans might not seem related at first glance, but if you use it right, a health savings account (HSA) is a useful tool to help you reach retirement goals. You won't pay federal taxes on money you contribute to your HSA, and you won't pay taxes on withdrawals for most medical payments. After you turn 65, you can take money out for any reason, but your withdrawals will affect your income tax liability. You can invest your HSA funds into stocks and bonds, but only 6% of accounts take advantage of that option. If you have an HSA, take the time to invest those funds. Most people pick investments similar to their 401(k) or IRA.
Tax Refund Strategy
Getting a tax refund check is fun, but if you're trying to bolster your retirement savings, you should deposit that refund directly to an IRA or HSA. You can automatically redirect that money to retirement accounts using IRS form 8888, and that can help minimize the taxes you'll pay on that extra cash. If you can't put that money directly into an IRA or HSA, you should at least deposit it into a savings account (not a checking account), so you aren't tempted to spend it right away.
Don't Burn Your Bonus
Similar to the tax refund strategy, you should try to invest any bonuses you get at work. Bonuses and other unexpected sources of income shouldn't be relied on for meeting basic needs. Since you don't need the money to make ends meet today, you should set that money aside for your future. Extra income is also subject to taxes, so investing that money in a retirement account can help you reduce your tax liability.
Set Aside Equity When You Sell
If you own a home but may sell it in the future, you should plan to set aside some of the money from your sale to bolster your retirement coffers. You can exclude up to half a million dollars of home sale profits from your income taxes, so use some of that money for an after-tax retirement plan like a Roth IRA. If you're not looking to sell anytime soon, you should at least plan for retirement by figuring out whether you'll downsize or move to a cheaper city in your retirement years and how much of your home's value (or "home equity") you'll set aside for general retirement funds.
Make a Plan Today
No matter how you're saving for retirement, the best strategy is to make a plan today. The sooner you get saving, the more those savings will be able to grow. As long as you're making ends meet, you'll never regret putting money away for retirement. Figure out when you want to retire, how much money you want to retire with, and what you need to do to make that happen.