We often delay financial planning when it comes to retirement because it drums up thoughts of old age and mortality. But you’re doing yourself a major disservice if you don’t prepare for it as soon as possible. A helpful way to look at saving for retirement is to reframe the idea entirely. “Think of it as saving for options in your future, like the ability to make the decision to stop working at some point or travel,” said Arielle O’Shea, personal finance expert at Nerdwallet,. “If that word is dragging you down, think about the sort of freedoms that come with it. That can help young people can identify with it.”
And yes, you should start thinking about it as soon as possible. “There is a huge advantage to starting your retirement fund early,” said Mark Sette, certified financial planner and portfolio manager at Wealthsimple. “The sooner you start, the more time you have to benefit from compound interest, the snowball effect where the interest you earn also earns interest, and the interest on that interest earns interest, and so on forever. The larger your balance gets, the more money your money makes.”
A retirement fund will basically feel like free money once you get there. And it’ll be yours for the taking, so long as you figure out the right type of plan for you.
Where to start
After you’ve decided on the financial institution in which you’d like to invest your money (one of the largest providers is Fidelity Investments, for example), decide on the type of account, which depends largely on your income, tax bracket and employment type. According to Sette, your main account type options include:
– 401(k) or 403(b): Your employer will often match a percentage of your annual contribution, which is deducted from your paycheck.
– Solo 401(k): Great for self-employed professionals, the solo 401(k) works like a traditional 401(k), but it only covers a business owner with no employees, or that person and their spouse.
– IRA: An Individual Retirement Account, or IRA, allows you to save for retirement with a lower income tax bill since the funds you contribute to this account are tax-deductible.
– SEP IRA: A Simplified Employee Pension Plan, or SEP IRA, allows you to contribute up to 25 percent of your net income.
– Simple IRA: This allows small business employees and employers to establish an employer-contributed plan without the costs associated with a traditional 401(k).
– Roth IRA: This works like a traditional IRA, however, you do pay taxes on the money you contribute (the limit this year is $6,000), and you don’t pay taxes on the money you earn in the account. If you earn over $135,000, you might not be eligible for a Roth IRA.
Employment retirement fund
Many full-time salaried jobs come with the benefit of a retirement fund. And it might be wise to actively seek out a position or employer that offers a robust plan. It might be difficult to visualize at your current stage, but retirement will play quite a significant role in your life.
“If your employer matches contributions to your 401(k), it’s a guaranteed return on your investments, so it’s a great benefit to have. Then invest first in tax-advantaged accounts (IRAs), then taxable accounts once those are maxed out,” said Sette.
Keep in mind that 401(k) matching is part of your compensation package, so factor that in when comparing salaries from multiple offers.
Self-employment retirement fund
You’ll have plenty of guidance from HR or your company’s plan provider when contributing to your employment-issued retirement fund, but in this gig economy, many professionals are left to fend for themselves. “If you are self-employed, a SEP IRA is a great option since you can contribute substantially more than with a traditional or Roth IRA, about 25 percent of your income or up to $54,000.”
The benefits of opening it on your own include freedom to invest your money at an institution of your choosing, and when and how much you want to contribute. “Since every contribution is taxed now, this account gives you an immediate idea of how much you’re saving for the future, and what you’ll have when you withdraw from this account in retirement,” Sette said.
He added that every amount you contribute to your traditional IRA is deducted from taxable income as a self-employed professional, which translates to more money in your wallet.
Traditional 401(k) vs. Roth 401(k)
Now, you’re probably curious about the difference between the two most common private sector employer-issued retirement accounts. For both the 401(k) and Roth 401(k), the maximum contribution this year is $19,000, which excludes your employer contribution match. If you have a 401(k), you’ll contribute pre-tax dollars, thereby reducing your current taxable income. This will be taxed once you take it out, according to O’Shea. For the Roth 401(k), your contribution comes out of your paycheck after taxes, therefore not reducing your taxable income. Think of it this way: if two people get to retirement with $100,000, one in a standard 401(k) and the other in a Roth 401(k), the former will amount to something closer to $80,000 or $85,000, because it gets taxed when you take it out of the fund.
“The big question is you need to decide on factors most notably like what your tax rate is now compared to what you think it will be in the future,” said O’Shea. “When you’re 35, you have no idea what your rate is going to be in the future. A lot of people think it’ll go up so they pay the taxes now [in a Roth 401(k)] to avoid it.”