Invest for Retirement
Investing for retirement is one of the most crucial financial steps you can take to secure your future. The earlier you start, the more time your investments have to benefit from compound interest, which can significantly increase your retirement savings. By carefully planning and consistently contributing to your retirement fund, you can build a financial cushion that supports your desired lifestyle in your later years, providing peace of mind and financial independence.
How Much You'll Need to Accumulate for Retirement
One of the first steps in planning for retirement is determining how much you will need to maintain your desired lifestyle. Financial experts suggest aiming to replace approximately 70-80% of your pre-retirement income. For example, if your annual income is $100,000 by the time you retire, you should expect to spend $70,000 to $80,000 per year in retirement. Depending on your life expectancy, health care costs, and other personal factors, this could mean accumulating anywhere from $1 million to $2 million by the time you retire.
That may sound like a big number, but by starting to invest early you can leverage compound growth to accumulate significant retirement savings.
The Benefits of Tax-Advantaged Retirement Accounts
Investing in tax-advantaged accounts can significantly enhance your retirement savings. These accounts offer various tax benefits which can lower the taxes you have to pay, enabling your investments to grow more efficiently over time.
1. 401(k) Plans
A 401(k) plan is an employer-sponsored retirement savings plan. Employees can choose to have a portion of their salary automatically deducted from their paycheck and contributed to their 401(k) plan.
In a Traditional 401(k) plan, contributions are made with pre-tax dollars, which reduces the amount of taxable income for the year. This means you pay less in taxes today and defer taxes on the money until you withdraw it in retirement. Withdrawals in retirement, including both contributions and investment earnings, are taxed as ordinary income at that time.
Some employers also offer the option of a Roth 401(k) plan, where contributions are made with after-tax dollars and are not tax-deductible, but where withdrawals are tax-free including both contributions and investment earnings. Since the balance in these accounts can grow significantly over many years due to compound growth, the benefit of tax-free withdrawals can be tremendous.
Employer Matching: Many employers offer a matching contribution, which is essentially free money added to your retirement savings. For example, an employer might match 50% of your contributions up to 6% of your salary. If you earn $50,000 and contribute 6% ($3,000), your employer would add another $1,500.
Investment Options: 401(k) plans offer a range of investment options, typically including mutual funds, index funds, target-date funds, and sometimes company stock. You can choose how to allocate your contributions based on your risk tolerance and retirement timeline.
Annual Contribution Limits: As of 2024, the contribution limit is $23,000, with an additional $7,500 catch-up contribution allowed for those aged 50 and older.
How to Automate Contributions: Contributions are typically deducted automatically from your paycheck. You can set up or change your contribution amount through your employer's benefits portal.
This video from Jarrad Morrow explains the advantages of a 401(k) and how it works.
2. Individual Retirement Accounts (IRAs)
Individual Retirement Accounts (IRAs) are accounts that you can open independently of your employer. The two main types of IRAs are Traditional IRAs and Roth IRAs.
With a Traditional IRA, contributions may be tax-deductible, depending on your income and whether you or your spouse are covered by a retirement plan at work. If they are tax-deductible, this would provide an immediate tax benefit, lowering your current tax bill. However, because of the interplay with employer-sponsored retirement plans and the uncertainty of future tax rates, we're fans of taking advantage of the Roth IRA instead.
A Roth IRA is funded with after-tax dollars, meaning you do not get a tax deduction for your contributions. However, the primary advantage is that qualified withdrawals, including both contributions and investment earnings, are tax-free if the account has been open for at least five years and you are aged 59½ or older when you withdraw the money.
Annual Contribution Limits: For both types of IRAs, for 2024, the contribution limit is $7,000, with an additional $1,000 catch-up contribution allowed for those aged 50 and older.
How to Automate Contributions: Set up automatic transfers from your bank account to your IRA. Most financial institutions offer this service.
Consider consulting with a financial advisor to assess your specific circumstances and make an informed decision. Regardless of which type of IRA you choose, the most important thing is to start saving and investing for your retirement as early as possible to take advantage of compound growth and secure your financial future.
This video from Rose Han recaps the differences between Traditional and Roth 401(k)s and describes the benefits of a Roth IRA.
Retirement Savings Goals & Tips by Age Group
According to a 2023 report by Vanguard, the average retirement savings by age group are as follows:
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Under 35: $30,170
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35-44: $67,270
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45-54: $129,051
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55-64: $215,500
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65 and older: $255,151
These figures highlight the importance of starting early to take advantage of compound interest and give your savings the maximum time to grow.
This video from Humphrey Yang provides savings goals by age and offers tips and strategies for what to focus on within each age group.
Optimal Sequence for Funding Retirement Accounts
To maximize retirement savings, consider this sequence for funding your accounts:
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401(k) Up to Employer Match: Take advantage of any employer matching contributions first, as this is essentially free money.
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Roth IRA: If you are eligible, contribute to a Roth IRA next, as it offers tax-free growth and withdrawals in retirement.
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Max Out 401(k): After contributing to a Roth IRA, go back to your 401(k) or 403(b) and try to max it out.
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Taxable Investment Accounts: If you still have additional savings capacity, invest in a taxable brokerage account for more flexibility.