Lafayette Federal Credit Union
Vice President, Business Development
Maybe retirement is just around the corner for you, or perhaps you’re just beginning your career and are starting to contribute to a retirement account. Either way, you likely have many questions, such as how much you should save, where you should keep your retirement savings, and more.
Regardless of where you’re at in your life stage, saving for retirement is something you should be taking seriously. Consider the following:
Let’s take a look at seven simple steps that can help to put you on a path to a sustainable and enjoyable retirement.
From a mathematical standpoint, it’s understandable that the earlier you start saving for retirement, the more savings you will accrue in the long run, especially given the power of compound interestOpens in New Window.
Unlike simple interestOpens in New Window, compound interest multiplies the interest rate by the principal plus the accrued interest each compounding period (also known as compounding frequency). The number of compounding periods is of key importance. A higher compounding frequency is to your favor, because the more often you apply interest to the principal, the higher the sum will be when interest is next compounded.
Here’s a simple example to illustrate the power of compound interest. Imagine that at age 20, you invest $150 per month in an account that earns 7% in returns and is compounded monthly. After 30 years of investing only $150 per month, you would have $182,995.65 by the time you turned 50. If you continued investing $150 per month until age 60, you would have $393,722.01.
On the other hand, let’s say you start investing at age 25. If you invested $150 into the same account each month, you would have $121,510.75 by the time you turned 50. And if you continued investing until age 60, you would have $270,158.19. A mere 5-year difference can have a significant impact on your future investment earnings.
However, if you are unable to start saving for retirement until later in life, don’t panic. You can still set yourself up for a comfortable retirement, which usually means adjusting to allow for greater regular contributions to your retirement account. If starting to save in you’re in your 40s or 50s, you should still plan on saving and will have some time to save a substantial amount of money for retirement. The key is to start saving as early as you can to maximize your post-retirement income.
There are different kinds of retirement account options available. Let’s explore a few of the most common methods ones.
Individual Retirement Account (IRA)
An Individual Retirement Account (IRA)Opens in New Window is one of the most common types of retirement accounts. You can work with a credit union, bank, or investment company to get started on opening an account. Once you start making contributions, you’ll choose specific investments for your savings within the account.
The two most common types of IRAs are Traditional and Roth accounts. The major difference between the two lies in the way each one is taxed. With a Traditional IRA, your contributions are tax-deductible for that year. You pay taxes on that money when you take distributions in the future.
A Roth IRA is tax-exempt. You pay taxes on the money you contribute in a given year, but withdrawals are tax-free in retirement. For savers who believe their tax bracket will be higher in retirement, a Roth IRA offers attractive advantages. However, you can’t contribute to a Roth IRA if you make over a certain amount. In 2022, the income limit for singles is $144,000. The limit for married couples is $214,000.
One thing to keep in mind is that both Traditional and Roth IRA accounts have an annual contribution limitOpens in New Window. In 2022, the maximum contribution limit is $6,000 for those under 50 years old. If you’re over 50, you can make an additional ‘catch-up’ contribution of $1,000 per year. These limits do not apply to rollover contributions (if you’re transferring savings from another retirement account).
A 401(k) accountOpens in New Window is a retirement plan offered usually by an employer. Self-employed individuals can also open a Solo 401(k)Opens in New Window. One of the biggest perks of a 401(k) is that many of the employers who offer them also offer to match the employee’s contributions up to a certain amount. The match the employer offers can differ, but it could be as high as dollar-for-dollar. This additional contribution amount from an employer is a great way to fast-track your retirement savings.
The annual contribution limit for a 401(k) is also higher than the contribution limit for an IRA. In 2022, the contribution limit is $20,500, which is $1,000 more than the limit in 2019. This equates to over $83 more per month you can contribute. Additionally, individuals over 50 years old are allowed to make an additional catch-up contribution of up to $6,500.
Similar to IRAs, many 401(k) plans are available as Traditional or Roth accounts. Employers who offer both types may allow you a certain degree of fluidity between the two. For example, if your employer matches your contributions to a Roth 401(k), their matching dollars may go into a traditional 401(k)—which means that you’ll end up having access to both types of accounts.
If your retirement account comes from your employer as part of your benefits package, you may have limited control over the type of account you have. However, you can always open an IRA in addition to any 401(k) accounts you have access to.
To determine what type of account is best suited for your financial goals, it’s a good idea to set up a meeting with a financial advisor, who can provide custom recommendations based on your goals and circumstances.
Once you’ve set up a retirement account and you are starting to build your portfolio, it’s time to strategize. Determine how much you can reasonably save towards retirement per month. You should also consider your retirement goals and work backward (either independently or with a financial advisor) to calculate how much you need to save per month to reach that goal.
Next, you’ll need to figure out the best investment strategies to best maximize your accounts while meeting your financial goals. There are two main objectives to making sure you are saving as much as you can: minimizing losses and maximizing gains.
To minimize losses, you should try to avoid unnecessary fees, taxes, and mistakes that could lose you money; for instance, leaving a contribution-matching employer before you are fully vested in the planOpens in New Window. Choose investments that have low fees. When you’re just starting out, a robo-advisorOpens in New Window may be able to help you make basic investment decisions for little to no cost.
To maximize gains, try to contribute as much as you can, take advantage of any available tax breaks, and choose an employer with a good 401(k) matchOpens in New Window. If you are a lower-income worker with a 401(k), you may be entitled to the Saver’s CreditOpens in New Window. Depending on your income and marital status, you could even receive a tax credit of up to 50% of your 401(k) contributions last year.
A common mistake made by young investors is to withdraw money from a retirement account prior to retirement. You may feel like that money can be more useful to you now than later. But try not to give in to this temptation. You’ll have to pay steep withdrawal penalties and taxes, and worse yet, you’ll have to start from scratch when you start saving again!
Life happens. Your income situation isn’t likely to stay exactly the same throughout your entire working life (or your retirement). Hopefully, the changes are for the better, but sometimes we fall on tough times. It’s important to know how to respond to life changes when it comes to saving for retirement.
If you find yourself making more or less money in a given year, your retirement contributions should reflect this. If you have a 401(k), you should already be contributing at least up to your employer match (this is ‘free’ money that you’re giving up if you’re not). When you income increases, a best practice is to maintain your standard of living and invest the extra cash into your retirement savings.
Being flexible and increasing your contributions when you can requires discipline, but it works both ways. If you find yourself making less in a given year, you can decrease your contributions temporarily. Just remember to reset once you’re income increases again. The key is to regularly contribute to your retirement portfolio as much as you can.
Consistency is the most rewarding way to grow your retirement. If you are a young investor, you are in a good position, as you have many years ahead of you in your working life. This equates to many paychecks’ worth of contributions to your retirement plans. Your future self will thank you for thinking ahead!
And if you are beginning to save for retirement later in life, consistency is even more imperative. There may be a little less wiggle-room for mistakes and you may have to contribute a higher percentage of your income. But when it comes time for you to retire, your hard work will have paid off.
When it comes time to making decisions with your finances, you need a financial institution that prioritizes your financial education, clarity, and well-being.
At Lafayette Federal Credit Union, we can help you get you on the best path for your retirement savings journey, and provide support along the way Learn about our investment optionsOpens in New Window, and reach out to us today to get started.
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