Saving for Retirement

Once you are working and living on your own, you may feel a newfound freedom.   With your independent, adult status, however, comes new responsibilities.  You have to focus on your job, make sure you pay your bills on time, and pay down any debt you have.  Who wants to think about saving for retirement at this age?  Can’t it wait for later?  But, by spending some time understanding your current financial picture and making room in your monthly budget for retirement savings, compounding interest will do its part to grow your savings, giving you peace of mind about your financial future. 

Gain a firm understanding of your current financial situation

Once you find a job, you may be tempted to relax while those paychecks start rolling in.  Though you should enjoy your time away from work, it is equally important to spend time on your finances. Paying attention to the details now will help you in the future.

Begin by creating your personal balance sheet and tracking your cash flow.  A personal balance sheet details what you own, your assets, and what owe, your liabilities.  It can also tell you your net worth.  Your net worth is the difference between what you own and what you owe.

Your cash flow shows when you will get your pay and how much you will get.  It also shows all of the ways you use your income—daily living expenses, debt repayments, and savings. By knowing your current net worth and what your income is and where you are spending it, you can create a sound financial plan.

You may have large debt obligations like student loans, a car loan or high credit card balances.  You may also have high housing costs or be paying a lot for transportation.  Taken together you may not feel like there is anything left to save. Consider all your spending categories from the small to the very large.  Small changes, like turning off lights and appliances when not in use, to larger changes, like consolidating your student loans, may free up money that you can then direct towards retirement.

Start saving now, even if it is a small amount.

While working to pay off debt is important, the act of saving counts too – saving small amounts each month in a designated retirement account creates a savings habit that will carry you through all of your working years.

You may wonder how much you should save each month.  A typical rule of thumb is to save ten percent of your gross annual earnings for retirement.  With your debt obligations and expenses, this may not be possible now. But getting in the habit of savings will help.  Maybe you can start by saving 2% of your income and then increase the amount by another 2% each year.  That will get you to a 10% savings rate in five years.  Remember that once your cash flow becomes stronger, either through raises at work or by paying down debt, you will be in a stronger position to save a higher percentage of your gross income.

Educate yourself about your retirement savings options.

You now know that the act of saving when you’re young is important.  But the type of account that you save in will affect the rate of growth, too.  A typical savings account with low interest rates will compound minimally over time, while money saved in a more aggressive vehicle like a mutual fund has a greater likelihood of growing, but is also has a greater risk of losing value.

Some fear that the stock market is too volatile to risk their hard-earned cash.  What if the Great Recession happens again in our lifetime? While it’s painful seeing first-hand the hardships that families faced during the last downturn in the economy, the stock market is a place where you may see your savings grow the most over time.

Saving in a 401(k) or 403 (b) is a way to save through your employer using pre-tax dollars.  401(k) and 403(b) plans are defined contribution plans.  This means the amount you can put in and in some cases is matched from you employer is defined. 

The money you designate for savings in a 401(k) or 403(b) plan will come directly out of your paycheck before any tax is taken out.  Some employers will even provide a match to your savings, meaning that by not saving you are leaving free money on the table.  You can save up to $18,000 per year in a 401(k) or 403(b).  If you are over 50, you can contribute up to $6,000 more per year.  This is called the “catch-up” provision.

If you do not have the option of a 401(k) plan at work, you can open your own Individual Retirement Account (IRA) using after-tax dollars. There are two general types of IRAs:  Traditional and Roth. Here are the key differences:

	Traditional	Roth
Contributions—the money you put into the account	Tax-deductible	Not tax deductible
Distributions—the money you take out at or after retirement.  Your contributions + earnings.	Taxed	Not taxed
Maximum income level to contribute	No maximum	If married and filing jointly: Modified adjusted gross income--$184,000 or less You can make a reduced contribution if your modified adjust groups income is between 184,000 – 193,999 You can’t make a contribution if your income is $194,000/year or more. If you are single head of household or married filing separately: Modified adjusted gross income--$117,000 or less You can make a reduced contribution if your modified adjust groups income is between 117,000 – 131,999 You can’t make a contribution if your income is $132,000/year or more.
Maximum annual contributions for ALL IRAs combined	$5,500/year	$5,500/year
Catch up provision for people aged 50 years or over	$6,500/year	$6,500/year

 

Adjusted gross income (AGI) is your taxable income, but it may not accurately represent your total earnings. Certain sources of income are untaxable, such as foreign investment income.

These untaxable sources are added back into your AGI to calculate your modified adjusted gross income (MAGI). So your MAGI is a better description of your ability to pay for education, adoption, or any of the other credits the Federal government may provide.

With an IRA comes the responsibility and freedom to invest the money how you like.  You can use the investment firm of your choice.  You can also set up an automatic transfer so that you do not need to make a conscious decision to save each month, it will just happen.

Within your 401(k) or IRA, look for low-cost accounts featuring low expense ratios.  While a 1 percent fee doesn’t look like much on the surface it can means losing thousands of dollars in savings over the long run, and no one wants to do that.  Seek out low-cost index funds and exchange traded funds (ETF).   Some retirement plans even offer automatic diversification or target-date funds that shift the ratio of risky to safe investments, as you get older.  Make use of the customer service personnel at these companies and ask many questions.  Unlike previous generations who benefitted from employer-sponsored pension plans, today’s workers are in charge of their retirement savings and so you need to have an understanding of how you are investing.

Finally, once your retirement account is established, do not tap into it for other uses like travel or a down payment on a home. Leave it there and let it work for you.