After you choose to leave the workforce, retirement is supposed to be a time of well-deserved relaxation after many years in the workforce. This dream can become a reality if the retiree has prepared for it. The best way to do this is to begin planning many years in advance.
Take Advantage of a 401(k) Plan
Many employers offer 401(k) plans to their employees. Taking advantage of these plans means taking a small amount of money out of each paycheck and saving it until a later date - ideally, when you retire. However, many people aren't making use of this tool. According to the U.S. Government Accountability Office, less than half of households age 55 and older have some retirement savings, while more than a quarter don't have a defined benefit plan or savings [1].
Beginning to save in your 20s and 30s is the best way to get ready for your retirement down the road. While this stage in your life might seem like it's a long ways off, it'll be hard to make up for lost time when it comes to saving money for it and a 401(k) plan is a great way to start.
Most employers offer their own contributions to those who participate in the plan. According to the Investment Company Institute, 83 percent of companies offer some sort of contribution, most of which offer a simple match formula. When an employer takes part in a match or contribution plan, it gives its participating employees free money just for investing in the plan. It would be wise to take them up on this offer.
When beginning to invest in a 401(k) plan, there are some things to keep in mind. While it's true that it's relatively easy to do, and the rewards are well worth it, it's also important to find the right way to do so.
When you begin a 401(k), you'll have to choose how to invest the money you set aside. Some employers will have a default option. According to The Motley Fool, these default options have improved in recent years from basic money market cash options, which presented little to no growth [3]. However, even though some company's default options have gotten better, choosing your own portfolio from the options given can improve your savings.
Decide How to Invest
Your employer should give you a list of investment options. There are typically five different varieties of opportunities, InvestmentPlace explained [4]:
- Stock funds
- Target-date funds
- Blended-fund investments
- Bonds
- Money Market Funds
Choosing how much of your investment to allocate to each should depend on several factors, including your personal risk tolerance, age and needs. One rule of thumb many industry experts refer to is subtracting an investor's age from 100. The remainder is typically a good percentage to invest in stocks, or riskier options. The rest should be in more secure options, such as bonds. That means that a 28-year-old would put 28 percent of his or her 401(k) allocation into bonds and 72 percent in stocks.
Roth vs. Traditional
Another decision you may have to make is whether your 401(k) will be a Roth or a traditional one. Motley Fool writer Selena Maranjian explained the difference between the two comes down to when the money will be taxed [5]. Roth accounts will be taxed before you put the money in, but when you take it out in your retirement years, no additional tax will be applied. If you opt for the traditional plan, the money will come out of your paycheck pre-tax, but when you withdraw it, it'll be taxed as ordinary income.
Deciding between the two comes down to how you see your future self in comparison to where you are today financially. If you are in a higher tax bracket now and expect to be in a lower one when you retire, waiting until that point to apply the tax might be the better option.
Saving for retirement might not sound like a big priority right now, but you'll thank your younger self for looking out for your future. There are plenty of ways to financially prepare for your post-career life, and 401(k) plans are a great way to get started.
Sources:
[1]. Most Households Approaching Retirement Have Low Savings
[2]. 2015 Investment Company Fact Book
[3]. 3 Critical 401(k) Mistakes to Avoid
[4]. A Beginner's Guide to Picking 401k Funds
[5]. 3 Things You Should Know Before You Sign Up For a 401(k)
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