RETIREMENT IS COMING
ARE you thinking about retirement? I know it sounds crazy if you are in college, in your 20s or like me in my early 30s. But no matter where you are on this journey you should be thinking about it. If you are in your 40s, 50s or 60s maybe retirement feels a little close, and you are feeling worried. Worry not – as long as you start planning today then you are not late or too early. Depending on where you are- your strategies will be different.
TARGETED AUDIENCE: Everyone with a special focus on the immigrant professional. You probably asked yourself-what the heck is a 401k anyway?
NOTE: This post is about regular retirement goals (after 60). I love the FIRE movement (Financial Independence Retire Early), but I am not sure that is for me. I have however learned a lot from the movement, and I encourage you to read as much as you can from them. FIRE folks aim to retire as early as 29 or 39. To meet those goals they live on less than 25% of their income and make so many sacrifices.
SO HOW DO I GET STARTED?
Bonus disclaimer: To prepare for this post I had two phone calls with financial advisors from our retirement management fund- you can call anytime and its free (double check to be sure), I also spoke to my bank then two financial advisor friends who donated their time. The advice was pretty consistent across the board which made me feel confident to write this blog. I have also been reading a ton of books, blogs and I LOVE reddit. However, there is a lot I do not yet know so please correct me and share knowledge from your experience.
How much do you need to retire? It depends on your current budget– you will need about 85% of your current income in retirement. Some advisors say this amount may even be too little because retirement lifestyle can be expensive. Enjoying retirement might include traveling more (without company reimbursement), and I don’t know about you, but when I am home, I eat more and shop more. At the same time, you may already be living a debt free life – No mortgage and no debt! PAY OFF THAT DEBT! BUT our kids might need more financial help, so there is that –
BEFORE we get bogged down with numbers, let’s think about the different ways available to us to save for retirement. Younger readers- I wish I had started saving in college or early 20s. You are at the best stage to start saving. I promise 🙂
Dave Ramsey, Nerd Wallet and a whole bunch of other money smart people say you should put at least 3% of your income towards retirement. However, 15% is better – but since many of us are still starting just putting something is good. My very first full-time job did not offer me an employer match or contribution so after doing my budget and looking at my debt I could only contribute $100 each paycheck. I worked that job for two years; the employer fund had great returns. I recently checked the account in preparation for this blog and my very small contribution has grown to $6,000. Just this quarter alone I made gains of $745 – YAY! I anticipate some losses in the next few years, but I am sure it will bounce back.
SAVING FOR RETIREMENT WITH EMPLOYER-SPONSORED (pre & post-tax) PLAN 401/403/IRA
- 401 (k) or 403(b) This is a pre-tax invest plan offered but employers. Breaking it down:
- Safe harbor Some employers put in money into your account whether or not you make any contributions. This is called a safe harbor contribution. These are rare but quite common in higher education. Yay to academia. The various schools I have worked for have each offered anywhere between 3 percent and 9 percent just because I worked there.
So, let us say Chipo earns $50 000/year and my employer safe harbor is 3% – each year her employer will put in $15 000 annually into her retirement plan. This is an additional benefit to your salary.
If Chipo does not add anything else according to this 401(k) calculator, she will have $232k for retirement at the age of 67 with a 6% rate of return.
- Employer Match: A more common plan is one in which the employer says if you put in at least 3% of your income, we will also put in 3% this would be a 100% match. Nice. So, you put in 3% and get 3% in free money- a lot of young people lose out on this benefit because they do not put in the minimum required to get the match. Others say they will match up to 3% so if you only put in 1%, they will put in 1% if it is a 100% match.
Back to Chipo with $50 000
3% self-contribution will be $1500/year
3% employer match $1500
Assuming a 6% rate of return starting at the age of 33 with $0 savings so far, she will have $445k in retirement. By putting in just 3% of her income, she has doubled her retirement funds.
- My fav situation is when you have both the safe harbor and the match. The lingo is a bit complicated- you can read more here. At a few universities, the contributions look like this
Your employer will invest safe harbor 3% regardless of what you put in
Your employer will then match up to 3% of your investment
You will put in 3% into your fund
Nice! Under this plan, you will get 9% invested towards retirement.
Assuming a 6% rate of return starting at the age of 33 with $0 savings so far, she will have $697k in retirement. This is the BEST!
Benefits of a 401(k) fund
- Tax benefits: If you max your pre-tax contributions to the allowed amount for 2019 which is $19 000 for those under 50 and an additional $6,000 for those over 50.
You will only be taxed on (annual income-tax contribution). This includes an employer contribution.
- You will have to pay taxes after retirement – this is when a ROTH 401(k) might look a bit more attractive.
- How do I know what plan is best? Let your budget inform you. There are seasons when you want to reduce your tax bill by contributing more.
- Shelter from creditors- Most plans offer creditor protection.
- Employer matches and contributions – discussed above. Most employers do not contribute to post-tax contributions.
- Secret: You can withdraw for certain things with no fines. For example, you can withdraw money towards your first home payment up to $50k and for a medical bill. I am excited about this option (my financial advisors were too). Most of us do not have access to family loans for that first house or substantial medical bill, and this is a nice option to have. You will pay yourself back with interest, and you may lose out on returns during the time the money is out, but you can also avoid ridiculous interest rates. It could be a win-win with the right kind of research and planning. -plans differ on this so please do a double check.
Downsides of a 401(k) fund
- Taxed at withdrawal – you could be in a higher income tax bracket at retirement
- You can only start withdrawing at age 59.5.
- Fines for early withdrawal for unspecified reasons.
- Some plans have high fees. Do check with your retirement plan about the associated costs. I received a tutorial from TIAA to understand my fees, and so far I am happy with what they offer. Almost every fund has fees so you should not let this derail you too much.
A Roth 401(k)
With the Roth 401(k) you get can still contribute the same max of $19,000 but after tax. This means that when you withdraw your money in retirement, you will not owe taxes (except on the interest). This is a good option if you are in a position to pay a higher tax bill- probably great for younger folks who may have lower responsibilities early on in their career.
HSA – HEALTH SAVINGS PLANS
This is a little-known secret. It is a great tax-free way to save for future health expenses during your healthier years. Your employer offers you two or three health care plans. One has low monthly payments and higher out of pocket (HIGH DEDUCTABLE). There is usually a max for what you pay out of pocket with either plan so you will not be entirely stranded. This plan allows you to add $3, 500 for an individual and $7, 000 for out of pocket costs. Some employers will also contribute to this plan – some make a 50% contribution which is very nice. The money will grow with interest. You only need to use the funds for health care expenses, and they roll over from year to year.
Your plan will give you a list of what is approved.
I set aside $500 for our family of two the first time I played around with this. I have been able to pay for co-pays, acupuncture herbal tea, some cold medication. I have a debit card linked to the account. If the purchase is not approved, it makes a huge BING sound lol.
Keep your receipts. You can ALWAYS submit for reimbursement.
Other things with health care: Check if your plan covers things like a gym membership, yoga- you can tell I love yoga. I go every day for two hours when I can. The costs can add up quickly.
Same as pre-tax but after you have paid your tax bill. For 401 the max is still $19,000. This is an option if your employer does not offer after tax.
In contrast, Roth IRA contributions are made with after-tax dollars. That is, they don’t reduce the amount of your gross income, or your tax bill, the year you make them. The tax benefit you get comes at retirement, when you don’t owe any income tax on the money you withdraw from your Roth IRA—because you already effectively paid it, back when you contributed.
If you withdraw after the age of 59.5, then there are no fees associated with the withdrawal or penalty. This means you get access to your money a whole decade earlier than with traditional 401k.
PRE-TAX – You reduce your annual tax bill by however much you put into the pre-tax plans. You will pay tax in retirement.
401(K) elective deferral plans – you can put in up to $19,000 for 2019.
HSA- If you have a high deductible health plan you can put in $3,500 for an individual and $7,000 for a family
IRA: this is the more popular plan-you can contribute up to $6,000 per year
DISCLAIMER: MoneyProfessor is my personal blog. I provide general information – not professional or financial advice. Opinions and representations on are my own. I am not providing financial advice or legal advice on my blog. I am only providing general information. You should consult a professional before making any financial or legal decisions.