If you ask any financial advisor when to start saving for retirement, their answer would likely be simple: Now.
It’s certainly not easy prioritizing investing for retirement. If you’re in your 20s or 30s, you might have student loans or other goals that seem more “immediate,” such as a down payment on a house or your kid’s tuition.
But setting aside a little every year starting in your 20s could mean an additional hundreds of thousands of dollars of accumulated investment earnings by retirement age. Retirement may also be the single biggest expense in many peoples’ lives. Think about it: You may be living for 20 or more years with no active income.
Plus, while your parents or grandparents may have had a pension plan that kicked off right at the age of 65, that may not be the case for many workers in younger generations. Instead, the 401(k) model of retirement that’s more common these days requires employees to do their own saving.
To see where you are heading with your savings you could use a simple retirement savings calculator. But here are more basics on how to get started on your retirement savings strategy.
Different Types of Retirement Plans
Here are the most common types of retirement accounts and who can use them. This isn’t a comprehensive list of retirement accounts, so it might be a good idea to discuss retirement planning with a financial planner or accountant.
401(k) or Other Workplace Plans
A 401(k) is a workplace retirement account offered by employers. Typically, you contribute a portion of your paycheck, pre-tax.
One of the benefits of using your workplace’s retirement plan is that your company may offer a “match.” A match is when your company contributes to your account when you do. The current average employer match is 3.5%, according to the Bureau of Labor Statistics.
At the very least, you might want to contribute to take advantage of your match since it’s essentially free money. You don’t have to stop there though—in 2021, the IRS set the maximum 401k contribution limit to $19,500, with an additional $6,500 catch-up contribution allowed for those older than 50.
These accounts are tax-deferred, meaning you pay income taxes when withdrawing the savings in retirement. One of the many benefits of using a 401(k) or similar workplace plan is that it lowers your taxable income. For instance, if you’re making $85,000 and you’re contributing $10,000 annually to your 401(k), then you’ll only be taxed on $75,000 of that income.
One of the downsides to a 401(k) is that withdrawing these funds early could trigger a 10% tax penalty in addition to income taxes. Other workplace plans include SIMPLE IRAs, 403(b)s, 457 plans, and Thrift Savings Plans. If you’re self-employed, you could consider opening a Solo 401(k) or SEP IRA.
An Individual Retirement Account or IRA is another account you may use to save for retirement. Like a 401(k), a traditional IRA is tax-deferred and provides a place for your investments to grow free from capital gains tax.
Again, tax-deferred means that the money is taxed upon withdrawal at retirement. Therefore, a traditional IRA also carries a penalty for early withdrawal. An IRA is an investment account that is not tied to your workplace. That makes a traditional IRA an option for those that are self-employed or freelancers.
Unfortunately, traditional IRA accounts have a much lower contribution limit: $6,000 in 2021 if you’re younger than 50. Those 50 and older can contribute $7,000 annually.
Like a traditional IRA, a Roth IRA is an account that you would open on your own, separate from your workplace. It’s also possible to contribute up to $6,000 into a Roth IRA each year, although how much is tied to your income. Here are the IRS rules for 2021: Roth IRA Contributions .
Both those covered by workplace retirement plans and those who are self-employed can contribute to a Roth IRA, although there are income limitations. In 2021, a single person earning under $140,000 can contribute to a Roth IRA. For married couples filing jointly, the modified adjusted gross income must be under $208,000.
Unlike a Traditional IRA and a 401(k), which are tax-deferred, a Roth IRA is tax-exempt. You pay income taxes on the money that is contributed to the account, but not when you withdraw the money. Even so, it should be a financial last resort to withdraw from a Roth IRA account.
Like all retirement accounts, Roth IRAs are also free of capital gains taxes, or the levies charged on money you earn from profitable investments.
What Is a Wealth Management Account?
Like a 401(k) or an IRA, a wealth account is also an investment vehicle. But unlike an account designed specifically for retirement, these accounts do not have the same tax benefits.
You might consider using a wealth account if you want to invest for a goal other than retirement, or you’ve “maxed out” (contributed the maximum allowable amount to) your retirement accounts.
Because a wealth account does not have the tax benefits of a 401(k) or IRA, it also doesn’t come with the same early withdrawal penalties. Wealth accounts are often called “after-tax accounts” because you contribute and invest money you’ve already paid income taxes on—and you pay taxes on the capital gains when you withdraw your cash.
Just like checking and savings accounts at banks, these accounts can also have maintenance fees.
Investing for Retirement
Once money has been contributed to a retirement account, it’s time to invest that money. To say “saving for retirement” is a bit misleading—really, it can be considered to be “investing for retirement.” And you can invest within any of the above-mentioned accounts.
If you have a workplace plan, you may be given a list of mutual funds to choose from. To choose a fund, you might want to determine whether the underlying investment is appropriate given your goals and risk tolerance. The categories are usually stocks, bonds, domestic equities, foreign equities, or emerging-market stocks and bonds.
You may also want to consider the management fees of the fund, called the expense ratio. This is usually expressed as a percentage which is subtracted from the amount invested each year.
For those without a workplace plan, you might want to open a retirement account, fund the account with cash, and then invest the money. Investors can do this by signing up for a traditional brokerage account if they want to pick and choose investments themselves. They might also consider a robo-advisor, or computer generated investing services.
Investing in retirement and wealth accounts is a great way to jump-start saving and investing for your golden years, whether you invest $10,000 or just $100 to get started.
The first step is to open an account or use the one that’s already open. You could also increase your contribution. If you’re opening an account, you may want to consider one without fees, which cut directly into your bottom line.
SoFi Invest® offers retirement and wealth management accounts. You can also decide how you’d like to invest the money within the account. If you are comfortable picking out your own stocks and funds, SoFi Active Investing may be the service for you. The platform charges no commissions for trading stocks, ETFs or fractional shares.
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