Money can be an intimidating subject for many of us. Our money exists within an industry that uses a vocabulary that sounds like gibberish to most, and retirement is no different. The fact that we have to translate this language for something so central to all our lives is a disservice.
Although the industry has put many of us in this position, there is room to take control. My goal is to take this world and put it in a lens that enables you to be more informed. This empowers you to make better decisions and put you in control of your finances. Who doesn’t want that? Let’s talk about one of the fundamental pillars of your finances – planning for your future.
Getting Started
Think of each of the different retirement accounts as different highways (or paths) to where you’re trying to go. The type of investment you use to travel down this road is the vehicle. These both hold importance to your desired destination.
Roads
The roads to retirement might contain 401(k), Roth IRA, Traditional IRA, Roth 401(k). Do these terms already sound like something that makes your head spin?
Vehicles
Stocks, Bonds, Mutual Funds, Target Date Funds, Annuities. More terms you don’t quite understand? We’ll get back to that.
How Much?
Typically, you’ll want to save 10-15% of your pre-tax income (including employer match). If this sounds like a lot, though, the critical step is to start with whatever you can. We’re talking as little as $10. That first step is all about generating positive momentum to get the car rolling. Finance is like physics. It’s much easier to keep an objection in motion once it’s already going.
Which Road to Take
401(k)
This is your company-sponsored plan that allows you to contribute pre-tax dollars towards your retirement. In many cases, your employer will also match a portion of your contributions (FREE MONEY!). For those that are in this situation (if you don’t know, ask your HR team), this is likely where you’ll want to start. Let’s take a look at an example:
Jane works for Boogle, who will match up to 5% of her contributions, where Jane makes $50,000. Throughout the year, Jane will contribute $2,500 pre-tax dollars to her retirement account while Boogle matches with another $2,500. If you were not to contribute, not only does the $2,500 get taxed, leaving you with $1,875. You’re no longer getting the free money, which turns into a difference of $4,375 a year!
The great thing about this type of tax-advantaged account is the high ceiling you get for contributions. In 2020, you can contribute up to $19,500, giving you a lot of room to take advantage of the tax breaks.
Roth IRA
With a 401(k), you’re receiving tax breaks on the front end. With a Roth IRA, you’ll receive the tax break when you take the money out later in life; both situations are fantastic. Roth IRAs also offer up additional flexibility to use the funds after investment if needed. Roth IRAs have become a go-to investment due to the tax advantages and additional flexibility. In 2020, the maximum contribution for most folks was $6,000.
Discount brokerages like Vanguard, Fidelity, and Charles Schwab are all places where you can set this up. Also, see this post about fees for where to put those investments.
Traditional IRA
Traditional IRAs are the opposite of a Roth IRA when it comes to the tax break. It’s similar to the 401(k) where the tax break comes on the front end for Traditional IRAs. Typically, you will be a higher earner later in your career, which would push you to utilize the Roth IRA vehicle instead. However, if you earn too much to qualify for the Roth IRA or you believe taking the tax break on the front-end may be a more generous benefit, then this might be the best fit for you. Note: Traditional IRAs don’t have the same flexibility as Roth IRAs when it comes to possible withdrawals.
Which Vehicle to Choose
Think of your commute to work. There are many different vehicles (stocks, bonds, mutual funds, target date funds, annuities) you can choose to buy or drive on your route. The fact of the matter is that even though we’d all love to have a fancy vehicle, most of us just need a reliable way to get us to work. That’s a lot like retirement.
If you ask around, you’re going to hear about get rich quick investments like cryptocurrency, the next hot stock, or that real estate scheme your friend has. The people that tout these things also never tell you when they lose their ass, like your uncle, who has never lost money to a casino. Just like diet fads, there are rarely reliable shortcuts to building wealth.
We are all going to have different financial situations, but that reliable car can work for all of us. That reliable car I’m referring to is Target Date Funds. During the course of your retirement planning, it makes sense to decrease your risk as you get closer to your retirement date. Target Date Funds are designed to do just that.
Take that favorite reliable car of yours and add some self-driving to it. You set where you’re going and when you plan to get there, and the car does the rest. That is the beauty of Target Date Funds. Someone smarter than both of us (or a computer) takes care of the day to day at a very low cost while you sit back and relax.
Conclusion
When it comes to your retirement, one of the best things you can do is just start. The inertia of compound interest is your friend. 401(k) matches are a great place to begin if your company offers one. If not, you can start with a Roth or Traditional IRA.
