We all know that we need to save for retirement.
It’s in the news, all over the internet, in commercials and at work. It’s nothing new.
But no one ever identifies the list of things we should be doing to put us in a good position to feel confident about our retirement.
Should I max out my 401k? Do I need an IRA as well? If I have a 401k, do I even need the IRA? Roth or Traditional?
The responses differ based on who you ask, and most don’t tell you why. So there aren’t many places to find good answers. So in this article, we are going to highlight the steps that we need to take to build financial security in very simple actionable bites so that you can get started today with clarity on what to do.
Before we get started, it’s prudent to state that retirement is obviously very personal, and we can’t give a blanket template for everyone, but I’m sharing what I’m doing in hopes that if you can see what others are doing, understand the why then it will be helpful for you to formulate your own plan.
So here goes on how to start building the foundation and getting in the habit of investing.
Step 1: Get Company Match
If your company offers a 401k program and provides a company match, then contribute at least the minimum required to get the company match.
The company match is money that your employer puts in your retirement account for you as a part of the company benefits. So essentially it is free money from your employer for your retirement. You should never leave these funds on the table so before anything else, make sure you are reaching the minimum requirements.
This is the absolute beginning place to start forming the habit of investing. It works well because you get a double benefit: 1. seeing your retirement account increasing and knowing you are making a good money move, and 2. because you get matching money from your employer (which feels like a reward) for making a good choice.
Step 2: Maximize Your HSA Dollars
If you have a high-deductible health care plan, then you are eligible for a Health Savings Account (HSA). This account allows you to save money for health expenses tax-free and you can spend the money on medical/dental expenses tax-free as well.
It’s important to note that you want to use an HSA instead of a Health Flexible Spending Account as it allows for the accumulation of funds year over year and it never expires so you can fund your HSA for years and use it when you need it. You can contribute a maximum of $3400 for single, $6750 for families per year and maxing it out allows you to plan for your health expenses (present or future). Many companies also give incentives for using the HSA and fund some of the HSA for you, so you don’t have to contribute the full maximum yourself. Again, this is FREE money, and we NEVER leave money on the table. Next is the IRA.
Step 3: Fund a ROTH IRA
Who here likes to pay taxes?
The Roth IRA allows for tax free growth, so any money you earn you get in your hand with no taxes.
I can take that all day.
So if you don’t have an HSA because you have a traditional medical insurance plan, then once you are hitting your company match, next you will want max out your contribution to a Roth IRA. It’s no secret that I am a big fan of the Roth IRA because of the ability to be used as an exit strategy, but if you cannot contribute because you are over the adjusted gross income (AGI), then contribute the maximum to separate Traditional IRA for after-tax dollars ONLY. It’s $6000 for 2019 and $7000 if you are over 50 and can make a catch-up contribution and roll over to a ROTH IRA in the future.
I usually divide up my contributions into monthly deposits over the course of the year, but in the past, I have used my tax return, bonuses, Dependent Care Flexible Saving Account reimbursements or unexpected money to fund the account.
Step 4: Take Care of the Kids
If you have kids, then you should (at least start) to contribute to your children’s 529 or college saving account. The idea is to get you in the habit and every little bit helps. So don’t think you need to dump $10,000 + into it. start where you feel comfortable
I always include saving for your child’s college education as part of your retirement savings because it helps protect you against having to mortgage your home, cash out or borrow against your retirement to help your kids. I say the 529, but you can use the saving vehicle of your choice, just ensure that it offers you the chance to transfer the savings to another child if your child decides not to go to college because they are a pro athlete, or are super smart and gets a full ride.
For example: If you live in a state like Florida you can use the Florida prepaid to save for college, other states like Ohio has the College advantage which gives a deduction for the first $2000 invested each year. Regardless of which state you live in, you can have a 529 or Coverdale saving account that grandparents and anyone else who would like to give you free money can contribute to.
I tend to be aggressive with the investment using age-appropriate index funds, but I am conservative with the contributions. I tackle two daycare bills a day to the tune of a mortgage AND a vacation house payment, so I plan to increase once the kids are in elementary school. Until then, I meet the minimum for the tax break, and that’s all.
Step 5: Get Out of Debt
I know this article is about investing, but getting out of debt is a way of investing’ as well.
If you are still working on/struggling with car loans, student loans, credit cards or some other revolving debt then once you’ve done the previous steps, the next one is to start aggressively working on paying down your debt.
Take a look at this example I calculated using bankrate’s credit interest calculator. If you owe $10000 on a credit that has a 22% interest rate, if you make the minimum monthly payment of $200, then you’ll pay $17,356.12 in INTEREST alone! That’s nearly double the $10,000 you owed!
However, if you increased your payment to $300 (just adding an extra $100) you’ll end up paying $5,596.10 in interest which is $12,000 + less.
By putting more money towards your debt you are basically guaranteeing yourself a return of over $12,000 over the course of the loan which you could invest and make into more earnings. Stock markets can average a 7-8% return, but it isn’t guaranteed. Paying down your 22% loan pretty much is.
If you are wondering why it’s step 4 and not step 1, it’s because it depends on the terms of your loan. If you are in a 22% APR situation on your credit card, then absolutely pay off your debt first. But if you are in a 4.99% APR, where you are only paying $50 a month in interest (or some other really low number that is equivalent to paying principal alone) then there isn’t a whole lot of rush beyond just wanting to be debt free sooner than later.
OR Alternative Step 5: Go Back and Max Your 401K
At this point, once you’ve funded your HSA and IRA, if you are completely out of debt, then go ahead and go back to your 401k and max out that contribution if you can. If you can’t, you are still okay since you have balanced yourself concerning your retirement account portfolios. As you continue to get out of debt, make more or add cash flow, then you will be better able to contribute more.
Step 6: Beef Up
Once you have invested in your kid’s college savings to your comfort zone go back and work on beefing up your emergency fund. Don’t worry that it feels like stagnant money since interest rates are low. Emergency funds are to be completely liquid, so you know the exact amount of money available at any time without fail. If you invest your emergency fund and the market is doing poorly when you need the money, then you will lose money when you need it.
Emergency funds should be available in the amount specified.
Step 7: Maximize taxable investments
If after the first six steps you still have money to sock away, then Kudos to you! Excellent work! You have free reigns to beef up your emergency fund to at 9 months or/and pursue some taxable investment accounts (ideally index funds as recommended by Warren Buffet) and a cash flow opportunity. Like in the realm of Real Estate (whether directly or using Real Estate Investment Trusts), self-directed investment accounts, etc.
Go Get Rich
You now have a general outline to help you plan for your future self. It’s a few small tweaks you can make right now to feel more confident that you have a plan of action and can maximize the most common tax-deferred retirement vehicles.
If you are doing a few, then now’s the time to beef up.
If you aren’t doing any, then now you know, and you can get started.
So what are you waiting on? Go out and Get Rich!