Eventually we will retire...
Updated: Jul 14, 2021
I'm not advertising E-trade, (I've never used it so can't speak to it) but this video is perfect.
Hey folks! Happy Holidays! Happy New Year! All that jazz. It's been a while because, as you know, holidays throw everyone off their game. It's a time of family, fun, (not much) rest, and some relaxation. But even during the holidays, I think about financial fitness so back to blogging we go!
Picture this...you're relaxing on a rocking chair with your favorite drink in hand. Sitting next to you is your significant other. You all smile at each other as your grandchildren play in the front yard of the house you raised your children in. It's the summer and they are down for their annual two weeks to spend with you all. Life is good.
OR...you and your girlfriends (or guy friends) are laid out on the deck of a cruise ship. This trip has become a tradition during y'all's retirement, and this year you are cruising around New Zealand and Australia which you've never been to before. You raise your glass, offering a toast to life, your friends, and this cruise. Hakuna matata.
Your dreams of what retired life may look like could be completely different from the two scenarios I've offered you. But one thing in common with any dream of retirement is that you need a way to sustain your desired way of living during that period of your life. While you may have odds and ends jobs during retirement, you should have them because you want to, not because you have to. You certainly don't want to be like the folks in the video above. What you need to make comfortable retirement possible is money. And that means you need to start now.
I know that retirement seems like a long way off, but time is a funny thing. Does anyone else feel like after college time sped up? I feel like I looked up one day and realized I was 29, or that it had been 7 years since graduating college and 11 years since graduating high school. Before we know it, retirement will be here, and we want to be prepared.
The easiest way to start preparing for your retirement is to put money aside. The majority of jobs offer some type of retirement plan and they typically do an automatic reduction of your pay as your contribution to the plan. Whether you are starting a new job, or continuing in an old one, you should reach out to your HR or Benefits department and understand how the retirement plan at your job works, if you haven't already done so. There are a few things you should understand about retirement funds off the bat:
Automatic reduction: As I mentioned above, most companies will have you at an automatic pre-tax reduction of your pay to contribute to the retirement plan they offer you. This is a way to ensure that you are saving up for retirement. One of my jobs had automatic reduction at 3%. My current job has it at 6%. You should find out what (and if) there is an automatic reduction going to your retirement and adjust it to the amount you want to put into your retirement. You should be putting something into your retirement fund (remember retirement is closer than you think!), so don't put the automatic reduction to zero. If it is at zero, increase it. You may think you can't live without that money now, but you certainly can't live without that money during retirement. And if you never see the money in your paycheck, you won't miss it. I would not put more than 10% into your retirement fund for work because of the tax implications related to different retirement plans (more on that below).
Matching: Many companies will match your personal contribution (automatic reduction) to your retirement fund up to a certain amount. For example, my current job will contribute up to 4% into my retirement fund, matching me if I am also contributing 4%. I could contribute more or less than 4% but regardless, my company will put in 4%. If I am also putting in 4%, then I am getting 8% of my pay into my retirement fund, and I only have to put in half. It's free money! As soon as I joined my company, I adjusted my contribution so that it matched what the company would put in. The company had me putting in 6%, but I reduced it to 4% in order to meet the match.
Vesting: Some companies have a certain number of years before your are completely vested in the company. If you leave your job, you receive all of the money you personally contributed into your retirement fund. However, depending on how long you've worked at your job, you may only receive a percentage of what the company contributed to your retirement fund. For example, if you are at a job for 2 years, you many only be vested at 50%. This means you get all of the personal contribution you made to your retirement, and only 50% of the contribution the company made. The rest they get back. If you stay 5 years, you may get 100%, so you get all of your's and the company's contributions. This differs by job (in my current company, we are vested 100% from day 1), so you need to understand what the vestment plan is for your company. This also means that regardless of what your company is putting in, you need to be contributing to your own retirement.
Types of Retirement plans:
Traditional 401K: A 401K is typically offered by for-profit companies and allows employees to contribute a percentage of their paycheck, pre-tax, to a retirement fund. Money placed in the 401K are not taxable until it is withdrawn from the account. This is known as a tax-deffered account, because you don't pay taxes on contributions now, you pay them on withdrawals later. You cannot touch the money until age 59 1/2. If you withdraw money earlier, you have to pay a 10% penalty as well as taxes on the money you withdraw.
Traditional 403B: A 403B is pretty much the same as a 401K, but they are typically offered by non-profit and/or tax-exempt organizations, and is considered a tax-sheltered annuity because it has less administrative costs for the employer to provide this plan than a 401K has. Both employees and employers can contribute to this retirement fund (like in the 401Ks), employees on a pre-tax basis. Like the 401K, you don't pay taxes until you withdraw from the fund. The age you can begin to withdraw from the 403B (without a penalty, but with taxes) is 59 1/2. Otherwise you are subject to the same penalty as the 401K. 403Bs are also tax-deffered.
Pension: A pension is a defined benefit retirement plan in which employers designate a certain amount of money that is paid out to you in installments or in one lump-sum during your retirement. The amount is determined by a formula including your salary, your time with the employer, and the employer's terms around retirement funding. This type of retirement plan is not as common anymore because the cost of administration is high. It is typically offered to government employees such as police officers.
Individual Retirement Accounts (IRAs): IRAs are retirement funds that individuals can set up and contribute to for their retirement. Contributions to IRAs are typically tax-deductible, which means you can claim it on your taxes and possibly receive an increase in your tax refund. Taxes are applied for withdrawals at ordinary income rates.
Traditional vs. Roth: There are traditional 401Ks, 403Bs and IRAs, and there are Roth 401Ks, 403Bs and IRAs. Traditional retirement funds receive their contributions pre-tax, and so taxes are applied only when you withdraw from those accounts. Roth retirement funds receive their contributions after taxes so you can withdraw from those accounts tax-free.
Contribution Limits: Each retirement fund has a limit to how much you can contribute each year. This limit is determined by the government. For 2019, employees who contribute to 401Ks, and 403Bs can contribute up to $19,000. For IRAs, you can contribute up to $6,000. These limits adjust for age. If you are 50 or older, you can contribute more in what is called the catch-up contribution limit.
Above lists the basic information about saving for retirement. And these are not the only retirement funds you can have; these are just the most common. All retirement funds are essentially investments that your company, or you, make on behalf of your retirement. While I've provided some basic information here, I encourage you do your own research starting with understanding what your company does for retirement, and contributing to your retirement plans. I currently have two plans: a 401K from my job, and a traditional IRA as a personal account. And I need to do better at maxing out my contributions to both (2019 goals anyone?!).
The biggest adversary to being prepared for your retirement is time. You're going to run out of it. So make the most of the time you have now. Putting a little away for retirement now, pays off a lot in the long run. What would you rather be doing in your retirement: sitting on that porch or that cruise, or working because you don't have the money? The choice is up to you.