How to Invest for Retirement

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The prospect of saving for retirement can seem like slaying an almighty dragon. If you’re still in your 20s, you may not have even begun to think about saving for the ripe old age of 66 (the “full retirement” age if you were born between the years of 1943 and 1954). However, the earlier you begin to think about saving for retirement, the better—and no matter what your age, you can benefit from learning more about how to tackle the “saving for retirement” beast.

What to Consider When Choosing How Much to Invest

Before you choose a retirement account type, you need to decide how much you will contribute. A few factors you should consider include:

1. Your age

The earlier you start saving for retirement, the more money you will have when you decide to stop working and enjoy your golden years. This is thanks to a principle known as compound interest or interest accrued on the interest that you’ve earned previously. A 25-year-old who puts $3,000 into an investment account that returns 7% each year (a conservative estimate, as the American stock market has traditionally returned more than 10% annually) each year for 10 years will have more than $338,000 when he retires, even if he doesn’t contribute another dime ever again after he turns 35.

On the other hand, a 35-year-old who saves $3,000 annually for retirement will have invested $90,000 of his own money by the time he turns 65, and will only be left with about $303,000. Younger investors have the power of time on their side—older investors need to play catch-up and contribute more money annually if they want to retire at the full retirement age.

2. Your income level

Ideally, you should aim to save a percentage of your income for retirement rather than a set dollar amount. Some employers offer a 401(k) match program where they will contribute an equal amount to your retirement fund as you do monthly, up to a certain percentage, essentially giving you free money for retirement. Try to contribute your employer’s highest percentage of matching or max out your contributions annually (more on that later) for the most robust retirement account.

Source: https://www.financialsamurai.com/maximum-401k-contribution-limit/
Source: https://www.financialsamurai.com/maximum-401k-contribution-limit/

3. Your emergency fund

 From a broken leg to an unexpected layoff at work to a sudden auto breakdown, life in unexpected. If you are unprepared for a financial emergency, you’ll have to take out loans to cover necessary expenses, which can lead to a years-long struggle with debt. Before you even think about saving for retirement, build up a $1,000 emergency fund that cannot be spent except in dire circumstances.

After that, you can start contributing to your retirement account—but you should still work to save up enough cash to cover about 6 months’ worth of expenses in your emergency fund.

Choose the Types of Retirement Accounts You Want to Use

There isn’t just one way to save for retirement. You can use any of the methods below or combine them to hit your saving and investing goals.

1. 401(k) or 403(b)

A 401(k) account or a 403(b) account is the easiest way for most people to save for retirement. You can authorize your employer to take a certain percentage of your paycheck each period and contribute it to a sponsored retirement account.

Beginning in 2018, you can contribute up to $18,500 of your pretax income annually to your 401(k) account if you are under the age of 50, and $24,000 if you’re over the age of 50.

2. Traditional and Roth IRAs

An Individual Retirement Account (IRA) is a type of supplemental retirement savings account that many individuals have in addition to their 401(k) or 403(b) accounts. If you have a traditional IRA, you do not have to pay taxes on your contributions, but you will have to pay up when you withdraw the money.

A Roth IRA is the opposite—you pay tax on your contributions when you make them, but you can withdraw the money tax-free during retirement. For most individuals, Roth IRAs are a better option because they allow your money to accrue interest without getting bogged down by taxes. IRA contribution limits are stricter than employer-sponsored plans; you can contribute only $5,500 a year to an IRA or $6,500 if you’re over 50 years of age. Limitations on Roth IRAs are also placed on individuals who make more than $116,000 annually and couples filing jointly who earn more than $183,000.

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If you are self-employed or you own a small business, you have the option of opening a simplified employee pension (SEP) IRA. A SEP IRA functions almost identically to traditional IRA with increased contribution limits. You can contribute either 25% of your annual income or $55,000 in 2018—whichever amount is lower.

These accounts are easier to set up than solo 401(k) accounts, so most self-employed individuals use a SEP IRA as their primary retirement savings vehicle.

4. Health Savings Account (HSA)

If you have a health insurance plan with a high deductible, you may be eligible to invest in a health savings account (HSA). You can save up to $6,850 in an HSA if you’re under the age of 55, and the money that you contribute is tax-exempt. You can also withdraw money from your HSA to pay for almost any medical expense that you could incur, including everything from co-pays to prescription medication to emergency room visits.

If you don’t spend the money that you’ve contributed, it rolls over indefinitely. Once you turn 65, you are free to withdraw the money you’ve saved for any reason but be aware that you’ll be subject to a hefty 20% fee if you withdraw money for anything besides medical expenses. You will also have to pay income taxes when you withdraw, even if you’re over the age of 65.  

Final Thoughts

Saving for retirement may seem impossible, but the truth is that all it takes to see massive returns is regular small contributions. A monthly contribution of just over $450 a month (less than what most people pay in rent) is enough to max out a traditional or Roth IRA. You can maximize the value of your retirement account by placing your money into a diverse array of stocks and bonds.

Check out Benzinga’s list of the best index funds of 2018 for more information on how to start.

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