Full disclosure: Right now, I have three retirement accounts that I pretty much ignore. One is from my current job at Refinery29. I set it up as soon as I qualified for enrollment, checked the box that allowed me to contribute the full amount, and promptly forgot the login info. I never even bothered to think about it until Priya and I started working on the Money Challenge over the summer, where on Day 10, we recommend you increase your allocations. The other two accounts are from past jobs, though there isn’t enough saved to make me feel confident that I can retire when I’m 65. Every time I see Priya, she brings up these accounts and how important it is that I roll them over. Every time, I promptly change the subject.I know I am not alone in my ambivalence toward retirement savings. 401(k)s are confusing. How do they work? What should I invest? How much? Should you have another retirement account like a Roth IRA on top of your company account? What the hell is matching? And why do my eyes glaze over every time I try to read an article about the right way to save for retirement?
I get it. It’s boring. And worse, it’s confusing. But that’s not a reason to not contribute. And yeah, it’s not the same instant gratification as buying a new pair of boots, but with some careful planning, you can save for the future and have some fun. (Also, let’s stop falling into the stereotype that millennials never think ahead and prove those old fogies wrong.)
When Priya and I started talking about this story, we tried to figure out how to make it interesting. And then, she presented me with the numbers — how much money you’ll make if you start investing in your 401(k) right this minute — and I just about fell out of my chair (and finally increased my allocation). If Priya’s numbers don’t convince you, I give up.
We made the following assumptions:
You’re 28.
You make $50,000 per year.
Your company matches 100% of the first 6% of your salary that you deposit into a 401(k) (more on what this means shortly).
Your portfolio will have an 8% annual growth over the course of your lifetime.
Option 1: You contribute 6% of your salary to qualify for the entire employer match = you contribute $3,000 and your employer contributes $3,000.
At 65, you will have $1,218,421.92.
Option 2: You contribute the maximum to your 401(k) = $18,000, of which the first 6% were matched dollar for dollar by your employer for a total of $21,000.
At 65, you will have $4,264,476.72.
Even if your employer isn’t matching your contribution, if you invest 6% of your salary into your 401(k), you’ll have more than $600,000 in the bank by the time you hit 65. And that assumes you never ever get a raise.
We’re talking a million dollars, people.
I asked Priya for help explaining all the confusing terms that trip me up when I’m trying to understand why and how I should invest my money in a retirement account. As usual, she was unfailingly patient and never once rolled her eyes when I asked a dumb question. She’s as passionate about encouraging young women to start saving for the future as I am. Lucky for all of us, she understands this stuff.
As for all of you out there who have student loan debt and think, I can’t save for the future when I’m still paying for the past— we haven’t forgotten about you. Contributing to a retirement account should be a priority, even if it’s just a little bit each month. After all, $3,000 a year is just a little more than $8 a day. Hopefully, the advice we offer ahead will make the benefits abundantly clear.
So let’s get started. Feel free to ask questions in the comments; we’ll do our best to answer them. And if you get too bored reading our advice, not to worry, there’s a slideshow of incredible vacation destinations at the end. Just think of it as a preview of your retirement life after all those years of hard work. First piña colada is on my future self.
Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a professional financial advisor for advice specific to your financial situation.
Further Reading:
I Spent $1,000 At Whole Foods On Just 17 Items
9 Unbelievable Stories About Working On Black Friday
How I Cut My Spending In Half
You’re probably familiar with the terms “IRA” and “Roth IRA” (we know you don’t live under a rock), but you’re not alone if you’re not 100% sure what they are — and if you need one.
A Traditional IRA (usually referred to simply as IRA) stands for Individual Retirement Account — basically, it’s an investment account similar to a 401(k) that allows you to save for your retirement. Depending on several factors, you can make contribution to your IRA on a tax-deferred basis by claiming that amount at tax time so you’ll receive a refund on the taxes you’ve already paid. This has the effect of lowering your overall tax bill for the year, Priya explains.
A Roth IRA is similar to a Roth 401(k) — you pay taxes today on the amount you contribute, so you don’t have to pay taxes when you access the money in retirement. Unlike a Traditional IRA, there are income limits on Roth IRA accounts. In 2015, individuals making less than $116,000 per year could contribute to a Roth IRA, as well as married couples who make less than a combined $183,000. Click here for more info about eligibility— and make sure to consult a tax professional if you’re unsure.
Like a 401(k) or 403(b), you cannot access the money in an IRA or Roth IRA until you’re at least 59-and-a-half. Additionally, there is a cap to how much you can contribute and a deadline to make those contributions, since there are tax benefits to investing your money in these accounts. You can contribute up to $5,500 to your Roth IRA or IRA until April 15, 2016, to qualify as a 2015 contribution. (If you’ve never had an account before, it can be good to take your year-end bonus and open an account with it while you still qualify for 2015 tax deductions).
That amount you can contribute usually changes every year. Note that if your company offers your a retirement plan such as a 401(k), you may still make the $5,500 contribution to your IRA. However, it likely won’t qualify for the benefit of being tax-deductible.
You might also wonder if you should have multiple personal retirement accounts. You can open as many retirement accounts as you would like, although Priya doesn’t think you need more than one type of each. She also recommends you keep all of these accounts in one place, so you’re not bouncing from bank to bank to check on your investments (except, of course, your company’s 401(k), which has to remain in-house as long as you work there). Even if you have multiple personal retirement accounts, you can only deposit $5,500 total per year.
Another thing to note — unlike taxable investment accounts, IRAs and Roth IRAs can only have one owner. Married couples cannot have a joint retirement account.
So how do you choose which kind of account to open? As we mentioned in the last slide, one of the biggest deciders is how much income you make. If you’re eligible— and you’re contributing to your company’s 401(k) — Priya suggests it could be wise to contribute to a Roth IRA while you can. Yes, you’ll pay taxes up front, but you’ll enjoy the earnings tax-free at retirement (when you will be paying taxes on your 401(k) earnings). Once you no longer qualify to make deposits toward your Roth IRA, the account will continue to grow until you’re eligible to make withdrawals.
So there’s no perfect science to determine which one is better. Priya recommends contributing to both accounts, so no matter what the future might hold, at least some of your funds will have an advantage.
You regularly contribute to your 401(k) — so do you really need a personal retirement account, too? It all goes back to whether your employer offers a match to your 401(k) and if you are maxing your match. If the answer is yes to both, and you still want to save MORE money, then you can consider opening an IRA or Roth IRA. This will allow you to maximize what Priya calls your “tax flexibility” — in simpler terms, it means that you’ll be paying taxes on some of your retirement funds up front and some in the future. It’s good to spread those payments out so you’re not saddled with a big tax bill when you start withdrawing funds at 59-and-a-half.
Also, it’s worth noting that if you have an old company retirement account sitting around collecting dust, you can roll that over into an IRA. There’s more info on how to tackle that project in the slide about rollovers.
Let’s start with the very basics. What kind of retirement accounts does your company offer? When our grandparents were employed, many companies (and the federal government) offered pension plans. When workers retired, they received a monthly check from their employer that was a percentage of their salary to support them in retirement. These days, with Americans living longer, it doesn’t make financial sense for businesses to support retirees for 20-plus years (which is the average length of time U.S. employees live after retiring) — especially if the former employees only worked for a company for a short period of time (10 years or less). As a response, Defined Contribution Plans have become popular over the last 20 years, putting employees in charge of saving for their own retirements.
Defined Contribution Plans — 401(k), Roth 401(k), and 403(b) (which are the retirement accounts for the non-profit sector) — are savings accounts offered by your employer so you can make qualified contributions to save for your future. “Qualified” means you receive a tax benefit, Priya explains — any money you put into the account does not get taxed as part of your income. Or, in the case of a Roth 401(k), any money you’ve saved is free from federal taxation when you access those funds in retirement.
It’s important to note the money you save in your company sponsored plan cannot be accessed until you turn 59-and-a-half without a penalty. The law was created this way so that you don’t tap those funds before retirement and spend your nest egg. There are certain exceptions, but this money should really only be thought of as completely off-limits. If you try to borrow from you account early, you might be jeopardizing your financial security at retirement.
We’ll dive into the idea of tax-free savings a bit more in the next slide, but that right there is just one of many reasons you should start contributing to your company’s retirement account: free money. If you’re taxed at a lower bracket, you pay fewer taxes. Plus (!), if you start saving right this very minute, you’ll make more money on your investments in the long run.
Not convinced you need to start saving RIGHT THIS MINUTE? Priya provided these numbers. Imagine your goal is to save $1 million by the time you turn 65.
If you started at age 25, you'd need to save $3,860.17 a year to hit your goal.
If you started at age 35, you'd need to save $8,827.45 a year to make the same amount.
That's 228% more! Need we say more?
As we mentioned on the last slide, a 401(k) is an employer-sponsored account that you can choose to deposit money from your salary before you pay taxes on it. Priya provides a simple math equation to show how you can make more money by contributing to your 401(k):
Say you make $50,000 a year and are in a 25% tax bracket. (You can figure out your tax bracket by looking here.) If you choose to not contribute to your 401(k), your entire salary of $50,000 is taxable, so you’ll pay $12,500 in taxes ($50,000 x .25).
Let’s say you elect to contribute 10% of your salary to your 401(k), or $5,000 ($50,000 x 0.1). You can subtract that 10% from your total salary:
$50,000 - $5,000 = $45,000
Which means you’ll only pay taxes on that $45,000 of income:
$45,000 x .25 = $11,250
You get to keep an additional $1,250 ($12,500 - $11,250) in your pocket (or, ahem, bank account) each year.
The same math applies for a 403(b).
And we haven’t even talked about about matching yet, which means even more free money! Stay tuned.
The Roth 401(k) is a newer option that employers are offering. The question you need to ask if you’re considering investing in a Roth 401(k) is will you make more money (re: move into a higher tax bracket) in the future. (I hope most of you are thinking, YES!) If that’s the case, it’s good to invest in a Roth 401(k) because you’ll pay taxes up front, but you won’t have to pay taxes in the future (re: when you do retire and you start drawing from the account).
The math we used above doesn’t apply to Roth 401(k)s — they don’t offer the same up-front savings. So, if you make $50,000 and have only elected to make contributions to your Roth 401(k), the entire $50,000 would be taxed first (at 25%), and then, your money is moved to your Roth account. Sure, there’s no obvious up-front benefit, but as Priya points out, you won’t have to pay ANY taxes on this money when you retire (and the money should grow year over year).
At Stash, Priya advises her clients to put a little into a 401(k) and a little into a Roth 401(k) if both are offered by your employer, so you are partially protected against higher taxes in the future.
Many businesses offer company-sponsored retirement plans, but they’re not all created equal. What makes some stand out from others is the company match. To incentivize employees to save for retirement, employers help by matching your contribution, explains Priya. It’s essentially like getting a raise — but you need to make sure you are maxing your contribution to take full advantage of the extra money.
It's fairly common for employers to offer to match 100% of your contributions up to 6% of your salary, Priya says. So if your annual salary is $50,000 and you contribute 6% of your gross income ($3,000 per year) to your company-sponsored account (401(k), Roth 401(k) or 403(b)), your employer will contribute another $3,000 per year. That’s basically a $3,000 dollar raise, plus it doubles your savings to $6,000 for the year. If you choose to only contribute $2,000 for the year, your employer will match that amount and make a $2,000 contribution, rather than the full $3,000 they would be willing to contribute.
This is really a no-brainer. If you’re not maxing your match, you’re ignoring free money. And your employer will never alert you to this fact (which is understandable). Don’t leave money on the table, period.
You’ve opened a 401(k) — now how much are you supposed to invest each year? There is a limit to how much you can contribute (and it changes each year). In 2016, you are allowed to contribute $18,000 of your income; check the IRS site for yearly updates. Some 401(k) enrollment forms allow you to choose the “max” option, which ensures you’re contributing the full amount each year.
The big question to consider when trying to decide how much to contribute is whether your company matches your contribution. If they do offer a match, you need to make sure you’re taking full advantage of it at the very least, Priya implores.
“Even if you are working to pay down student loan or credit card debt, maxing your employer match is the most financially savvy decision you can make,” she says.
If you have the ability to save more than the match, Priya suggests paying down your other debt first — unless that debt can't be paid entirely in a short period of time (say two to three years). If that's the case, you should split the extra money you can save between paying of paying off the debt and saving for retirement.
So is there ever a time NOT to contribute to your company 401(k)? It seems like a no-brainer, but I pressed Priya to make sure there were no loopholes. If you are contributing less than $5,500 per year to your 401(k) and your employer DOES NOT match at all, you might be better off contributing that same $5,500 to a Traditional or Roth IRA (which we’ll touch on in the next slides). If you’re disciplined enough to save after that income hits your checking account, those types of accounts offer greater flexibility, investment choices, and in most cases, lower fees, Priya explains. But if you think that you’re not disciplined enough — or if your company offers a match — take full advantage of your 401(k). To see if you qualify for a pre-tax contribution to a Traditional IRA or a Roth IRA based on your income level, click here.
I’m very much in the set-it-and-forget-it camp, but maybe a little bit too much so. You should be aware of how much you’re contributing and where the money goes once you deposit it in your account. But this might be the most overwhelming step in the whole 401(k) process. When I log on to my account, I am overwhelmed by options and then I shut down completely. Too many choices!
According to Priya, when it comes to investing, the number-one rule is diversification. When you’re properly diversified, your selection of investments are uncorrelated, she explains, which means some are doing well and other are doing poorly. I know that sounds counterintuitive, but she promises me you don’t want everything to be doing well at the same time, because then you risk it all going bad at the same time. Plus, there are studies that prove uncorrelated investments do better over time.
Without professional guidance, Priya suggests the smartest way to achieve diversification in your 401(k) is by utilizing a hybrid mutual fund called a Target Date Fund (TDF). (We talked about these briefly in the Money Challenge.) TDFs are a pretty common choice offered by company-sponsored retirement plans, and they are great because you don’t have to overthink your investment choices (or, like me, make blind guesses and hope you chose correctly). You just choose a TDF that corresponds with the year you plan to retire and the fund manager will do the picking for you. For example, if you’re 28 and plan to retire when you’re 65 (37 years from now), you would choose TDF-2052.
As Priya explains it, the fund manager will choose the allocation according to the time frame you have to invest. Someone with 30-plus years until retirement will likely have a higher allocation to equities (for growth), whereas someone with only five-to-10 years until retirement might have a higher allocation to bonds (for safety).
If your company plan doesn’t offer Target Date Funds, there is a general rule of thumb that you can use. Subtract your age from 120 and the remaining number is your allocation for equities (stocks). For example, if you are 35 (120 - 35 = 85), you might put 85% of your portfolio into stocks and the rest into bonds. You can also refer to this asset allocation wizard from CNN Money, which is super helpful.
If you work as a teacher, doctor, government employee, or other type of non-profit company, it’s likely you’ll be offered a 403(b) account instead of a 401(k). These accounts work pretty much the same way, Priya says. Your contributions are tax-deferred and, in some cases, your employer with match a percentage of your contribution. But the same advice we offered about your 401(k) still stands: The tax-deferral aspect coupled with a potential employer match are two pros of taking advantage of these accounts.
If you work for a small business or you’re a freelancer, you might not have access to a company-sponsored retirement plan. That doesn’t mean you’re off the hook. In the next section, we are going to cover the different options available if your company doesn’t offer a retirement plan. Hang in there, you have options...
Argh! Rollovers! This is one of those super-annoying tasks that hangs over your head. (Or is that just me?) Regardless, rollovers are so important, which is why Priya is always nudging me to take control of my own (which, I am embarrassed to say, I have still not done).
When you leave a job (regardless of the circumstances behind your departure), you can transfer the funds in your company-sponsored retirement account into a personal retirement account that’s in your own name (such as a Traditional IRA).
To initiate the rollover, you need to call the benefits department at your former company, advise them that you no longer work there, and let them know you’d like to roll your funds. They will cut a check for any contributions you’ve made and any vested contributions that your employer made and you’re required to deposit that money in your personal retirement account within 60 days.
The benefits department will ask you how you would like that check made payable. Ask them to include the name of the bank or investment company where you have your personal retirement fund (Charles Schwab or Fidelity, for example). It should look something like this:
Please make the check payable to Fidelity FBO Lindsey Stanberry
FBO stands for “For Benefit Of.” You should also ask them to put your personal retirement account number in the memo line of the check. The process shouldn’t take more than seven to 10 days. It’s also worth mentioning that some retirement funds will do the calling for you, if for some reason you can’t or don’t want to call your former employer’s benefits department.
So why do you need to go through this hassle? (And let’s be real, it is a pain to do this kind of stuff.) Well, there’s the obvious reason: Once you stop working for a company, you can no longer make contributions to that account. Secondly, your investment choices in company-sponsored accounts are limited to around 20 investments, Priya explains. “In a Traditional IRA, you have the entire investment universe to choose from, including a lot more cost-effective options, such as ETFs (exchange traded funds),” she says.
Also, you probably can’t deny the fact that you don’t login to your employer-plan website as often as say, your bank account. When you have all of your accounts in one location, they are a lot easier to manage and you’ll probably take better care of monitoring them, too.
It’s not quite so easy to invest your money in a personal retirement account as it is with 401(k)s, where you can simply choose a TDF and forget about it. Investing is super overwhelming — and we’ll be exploring it more in the future. But for the time being, you need some basic advice on how to invest the money you’re putting into your IRA right now. Your default might be to buy stocks in companies you’re familiar with — Facebook, Twitter, etc. There’s nothing wrong with having a few stocks in your account, Priya explains, but it’s not an effective way to achieve true diversification (which we touched on in our advice on how to invest your 401(k)).
The two primary asset classes you should focus on to build a foundation are stocks and bonds. There’s an easy formula Priya shared that you can reference to determine how much you should invest in stocks versus bonds:
120 - Your Age (30) = 90
So 90% of your investments should be in stocks and 10% should be in bonds. Priya suggests you start by looking at ETFs (exchange traded funds), which have very low fees because they aren’t actively managed. You’ll want to research stock ETFs and bond ETFs — Vanguard offers competitively priced products so you could start there.
We mentioned this earlier, but maybe you’re hoping there will be a loophole? You cannot touch the funds in your personal retirement accounts until you turn 59-and-a-half. If you do need access to the funds beforehand, you will be on the hook for the taxes as well as a 10% penalty.
There are exceptions to the 10% penalty rule, known as “hardship withdrawals,” that the IRS deems are only in the event of “immediate and heavy financial need.” These are usually things like medical expenses, qualified education costs, and the purchase of your primary residence. In these cases, you can get around the 10% penalty, but it is not easy to qualify and Priya says it’s not advisable to do so. The phrase “fund it and forget it” is a helpful way to think of your contributions. They are meant to provide income in retirement, so consider them earmarked as such.
The simple answer is...in order to protect you from tapping your retirement stash before you’re in your golden years. The IRS created a 10% penalty if you try to access your IRA funds before you turn 59-and-a-half. Yeah, it might seem a bit paternalistic, but it’s not bad to have someone protecting you from your spending habits. Having $1 million or more when you hit 65 sounds a lot better than buying the newest iPhone. (Your old one still works, right?)
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