Updated: Aug 29, 2021
It is never too early to start saving for retirement, especially if you don't want to wait until you turn 67...what a joke. We need to start thinking about these things, especially if you're in your mid-20's. All of that money the government takes out of your checks for Social Security, you will not see a penny of it until you are 67 years old. I mean, you can cash out at 62 years old but it will be reduced payments. If you want to retire early like me or have extra money, continue reading.
There are many ways to save for retirement but I am going to focus on the three main options: 401(k) plans, IRAs, and Roth IRAs.
1. 401(k) Plans: These retirement savings plans are offered by your employer. It allows you to contribute pre-tax dollars from your paycheck and your employer will usually match that (up to a certain amount or percentage). You will only be able to choose from investment options that your company provides.
If you cash out your 401(k) before 59 1/2, there will be a 10% tax penalty for that early withdrawal. You can also borrow from your 401(k) but we won't talk about that because the goal is to invest and leave it alone until you retire!
This type of plan has great benefits so make sure you find an employer that offers this as a benefit and matches a good percentage.
2. Traditional IRAs: Individual Retirement Accounts (IRAs) are managed by you. This type is tax deferred and withdrawals are taxed (hopefully the tax rate is not some outrageous percentage by the time you retire and withdraw). But do recognize that if you intend to be in a higher tax bracket by retirement, boy, you're going to pay! Like a 401(k), there is a 10% tax penalty for withdrawing before 59 1/2. The cool thing about this is you may be able to avoid the penalty if using the withdrawal for things like purchasing or building your first home, you become disabled, higher education expenses, medical expenses, etc. However, there are also tax benefits if you are within income limits.
You can only contribute up to $6,000 annually if you are under 50 years old and up to $7,000 if over 50 (time to catch up buddy!). You can open an IRA at any bank or brokerage firm. It's that easy as long as you have the funds. I also want to note that, for example, if you switch jobs and had a 401(k), you can rollover those funds into an IRA to keep building upon that investment. I recommend researching rates for different financial institutions before opening an account or determining your asset allocation.
3. Roth IRAs: These type of IRAs have a few differences from the traditional account. It is similar to Traditional IRAs but contributions are taxed. So, when you withdraw, it is tax-free. This is for someone who may be in a lower tax bracket now. So, pay taxes on your contributions now, especially if you're going to be in a higher tax bracket in a few decades - depending on how old you are now. Another difference from the traditional type is if you make a certain amount of money, you will not be able to contribute to a Roth IRA. The income limit if you are single is $140,000. So if you make $145,000 a year like me (ha! I wish), turn your attention to a Traditional IRA.
Unlike 401(k) plans, with both IRAs, you can manage your own investments. Whether it's in mutual bonds, stocks, bonds, ETFs, or annuities. You can pick individual stocks or mutual funds or find an advisor that will do the work for you.
There are many other options to save for retirement like Employee Stock Ownership Plans (ESOPs), Simple IRA Plans, and Defined Benefit Plans, but I just focused on the three most popular options you may have heard of. If you want another post on the other options, let me know! I'll break that down for you too. But, this blog is getting too long so I'll get back with you next week.
Hope you enjoyed and consider these options. No one wants to wait until they are 67 years old to be able to stop working...I know I don't.