Introduction to Retirement Accounts
Retirement today is a lot different than it was thirty years ago. On average, interest yields from a typical retirement portfolio have been decreasing since the highs of the 1970s. There are a number of tax benefits when putting your money into retirement. To receive the full benefit of these tax breaks, it is important to start saving hard and to start saving early.
Pick your Retirement Account(s) (Roth IRA Vs. 401k)
A 401(k) is an employer-backed retirement account. When people talk about their 401(k)s, they are usually talking about their pension investment. A 401(k) is part of the US Internal Revenue Code that deals with retirement plans and which defers the taxation of your periodic savings. Meaning you pay taxes on this income in retirement. A 401(k) allows you to accumulate the interest on the taxes you would have had to pay.
A Roth IRA is an independent individual retirement account that you can set up with an investment firm. A Roth IRA account can compliment your 401(k) or can substitute a 401(k) (if your workplace does not have a 401(k) option).
You put money into your Roth after taxes. Therefore, (when you reach 60 years old and have had the plan for at 5 years you) when you begin withdrawing funds they are tax free. You can also withdraw funds penalty-free to pay for a child’s education or a down payment on your first house.
Generally, the best place to start a retirement account is at work (a 401k). Many companies will match your contributions to your 401(k). This is essentially free money. If your employer offers a 401(k) you should almost always opt in. When starting your job search make sure to ask about their retirement/401(k) benefits.
Read more about how to choose a Roth IRA here
There is also a new US Treasury-backed IRA called, MyRA, which we will write more about in the next blog post!
There are two basic steps when planning for retirement. There are all kind of calculators online you can use. For a quick overview that includes your age, amount saved towards retirement, and year of retirement try this retirement calculator. The calculator will give you a general idea of what you should currently be saving.
- Determine what age you want to retire at. Most calculators are based off of retiring at 67.
- Figure out how much you need to live on in retirement. This is based off of your standard of living and current income.
- This amount includes: medical bills, medical insurance, car and housing insurance, cost of living and economic change.
- Remember this money is going to be used several decades from today. Factor in extra money for padding!
- Figure out how much you need to save in order to reach your income level.
- The amount you need to save if you need $80,000 to live is much greater then if you need $40,000 to live.
Track your Progress
According to financial planner, Charles Ferrell, to retire by the age of 65 you should have 1.4 times your annual salary in a retirement account by the time you are 35, 3.7 by the time you are 45, and 5 times by the age 55.
Maintaining and updating a retirement tracker is your key to success. Yearly evaluations of your retirement accounts should be completed. To make this easy try tracking your portfolio with this free excel template.
To learn more about tracking your retirement account’s health, Charles Ferrell’s book, “Your Money Ratios” is a great place to start.
In Summary: Save Early and Hard
The power of compounding interest is great. To take advantage of the tax breaks and interest rates of retirement accounts, you need to start saving early. So whether you’re rich or poor, young or old, working pay check to pay check or affluent, start participating in a 401(k) plan or other retirement account. Every day you wait you are making the road to retirement more challenging.
It is America Saves week so start your retirement account today!