Retirement can be hard for people to understand because it’s not something you can buy, but it’s something you need money for. And it’s not something you need money for in a few years, like buying a house or car. It’s something that, for most people, is decades away. But financial companies and even your employer are trying to get people to think more about saving for retirement because for most of us, we can’t work forever. This guide helps you understand how to save for retirement
When is the right time to start thinking about retirement?
Retirement, in general, usually enters your life the first time you get a job with an actual paycheck. Each paycheck you get has money deducted from it that goes toward Social Security. That’s a government program that provides retirement benefits, as well as disability and survivor’s benefits to Americans.
But the idea of saving for retirement probably won’t enter your life until you get a full-time job. It happens when your company offers something called a 401(k) plan. These are employer-sponsored retirement plans. Your employer takes money out of your paycheck and invests it for you via an outside company. Companies can also provide a financial incentive in the form of a match, allowing you to save more for retirement. A 401(k) is often the first time that people start actively saving for retirement.
Why do you need to save for retirement?
Individuals are living longer than ever, but the retirement age hasn’t changed much. The average retirement age for Americans is 62. However, many of us are living until almost 80, and a chunk of us make it to over 100, which means we will need some form of income for at least 15 years after our last paycheck.
Years ago, it was the protocol for companies to “provide” for your retirement through pensions, or defined benefit plans. But according to a recent Willis Towers Watson study, only 16 percent of “Fortune 500” companies offered a defined benefit plan, whether it was traditional or hybrid (with a 401(k)), to new hires. This is a drop from 20 years ago when 59 percent of the same employers offered jobs with pensions.
And while Social Security can provide some financial help, individuals can no longer solely depend on the system to take care of all their financial needs. For those of us who aren’t living like Scrooge McDuck, we need some kind of backup plan. This is where saving for retirement comes in.
Retirement planning can help you figure out how much money you will need when you are no longer working. Recent research from the TransAmerica Center for Retirement Studies shows the average income for a retiree is $32,000. The number is higher for married retirees ($48,000) and much lower for those who are unmarried ($19,000). The majority of this comes from Social Security retirement benefits, but many say they still struggle with everyday expenses. Proper planning can help you avoid that struggle and allow you to live your retired life to the fullest.
How to save for retirement
There are many different investment vehicles to help you save for retirement. The easiest way for many of us is to use a 401(k) through our company. It will automatically deduct money from your paycheck and put it into an account. Then you invest the money in a mix of stocks, bonds, and cash. How the money gets invested depends on the company you are with. Some companies let you choose how you want to invest while others give you a suggestion based on your risk profile. Others will put your money in their own selection of investments based on the year you will likely retire. The older you get, the less risky your investments tend to become as you will be needing more of that money sooner.
Even if you leave the company, the money in this 401(k) will continue to be invested until you decide what to do with it. You can roll it over into another account (where it will still be invested), you reach retirement age and start getting disbursements, or you cash it in.
Individual Retirement Accounts, or IRAs
Individual retirement accounts are like 401(k)s, except they are not provided by your employer. You can open an IRA by visiting a local financial services firm, or even finding one online, and creating an account. It is similar to a 401(k) in that your investments will be based on your risk profile and other retirement needs. Some companies provide you with an adviser to understand your needs and help you create a retirement plan. These retirement planners will look at all aspects of your life and ask you questions about how you anticipate your lifestyle to be once you’ve retired. From there they will formulate an amount you need to invest in order to achieve those goals when you reach full retirement age.
Unlike a 401(k), where the money is taken out of your paycheck, you will need to have money transferred from your checking or savings account on a regular basis to mimic a 401(k).
Traditional IRAs vs. Roth IRAs
With a traditional 401(k) or IRA, taxes will not be deducted until you start taking disbursements on the money. This means that the money you invest is actually tax deductible each year when you file your taxes. When you start taking disbursements, you will pay taxes on the amount then, whatever your tax rate might be.
However, there is another form of retirement account called a Roth. This type of IRA takes out taxes before you invest the money. This means that when you retire, you’ll get whatever money you are being disbursed, tax-free. This can be really useful if you expect to be in a higher tax bracket when you retire. You cannot deduct Roth contributions from your yearly taxes. However, there are certain limits to who can invest in a Roth and how much you can put in.
Roth IRA Limits
There are some basic rules for those wanting to contribute to a Roth. The main rule is that how much you can contribute depends on your adjusted gross income. As you make more, the amount you can contribute decreases. At a certain income level, you are no longer able to contribute — at least in the traditional way.
Can contribute the maximum of $5,500 (or $6,500 if over 50)
Single/Head-of-household: $120,000 or less
Married Filing Jointly: $189,000 or less
Can contribute a reduced amount
Single/Head-of-household: $120,000 to $134,999
Married filing jointly: $189,000 to $198,999
Not eligible to contribute
Single/Head-of-household: $135,000 or more
Married filing jointly: $199,000 or more
There’s more to Roth IRAs, but these basics can help you decide if it’s a good choice for you.
Using an HSA as a retirement vehicle?
Health Savings Accounts are frequently a topic of conversation when starting a new job or getting a new insurance provider at work. Most people think of them as an alternative to a PPO or HMO. However, for those in the know, an HSA can be a secret retirement fund.
An HSA is an alternative to a Health Maintenance Organization (HMO) or a Preferred Provider Organization (PPO), where you have a high-deductible health plan and no other health insurance. You can contribute money via your paycheck. This helps offset your taxable income, or via additional funds, which are tax deductible. Most people who have this account carry a small balance for use as its intended purpose, taking care of medical expenses, such as doctor and specialist visits.
But for many affluent Americans, they max out the contribution amounts, which currently are $3,350 for individual health plans and $6,750 for a family plan. But they pay out of pocket for medical expenses, allowing their HSA money to grow throughout the years.
HSA vs. FSA
Many of you might be wondering what the difference between an HSA and an FSA. Well, an HSA can be used to pay for medical expenses but can also be used as a retirement investment. A health savings account can be used to pay for doctor’s visits, procedures and the like. But you can also let it sit, untouched, earning money for as long as you don’t use it. Your HSA carries over with you from job to job as well.
An FSA is a Flexible Spending Account. It’s also used for health care, including eye doctor’s visits. However, you can only contribute a maximum of $2,650 to it. These funds must be used by the end of the year they were distributed. Otherwise, you will lose them.
Interesting HSA Facts
Once you put money into an HSA, it grows tax-free. You can use that money without penalty at any time on qualified medical expenses without facing any tax penalty. If you do decide to use it on something other than a medical expense before retirement age (65), you will face a 20% penalty. Once you reach 65, you are allowed to take as much as you want and use it for what you want, there are no required minimum distributions.
The HSA is definitely a health plan, but it is often used as a third investment account next to 401(k)s and IRAs. While it is still best to use this for medical expenses, which have a tendency to jump as you age, it can be a nice addition to your retirement savings if you plan correctly. When planning your retirement, make sure think about how this money could be used for long-term care facilities, hospital stays and more.
How much should I save for retirement?
Again, this all depends on the kind of lifestyle you would like to live in retirement. If you plan on living modestly in a house that will be paid off, you likely will not need as much in retirement savings as someone who wants to travel the world and spend money on their grandchildren. Certified Financial Planners can help you plot out your savings and investing plans so that when you are retiring, you won’t need to worry about potentially running out of money due to illness or unexpected expenses.
Article last modified on January 17, 2019. Published by Debt.com, LLC . Mobile users may also access the AMP Version: How to Save for Retirement - AMP.