Are you prepared for retirement? If you’re under 30, or even under 40, you might think that you’ve got plenty of time to get there. You might even have a retirement plan such as a 401(k) or a Roth IRA and contribute to it regularly. That’s great, but it’s not enough.
At Addition Financial, we have a responsibility to our members that includes helping them with retirement saving and retirement planning. There are money management strategies that can help people of any age learn how to prepare for retirement. We’ve created this guide to help you understand what to do and when and how to do it to make sure that when you get to retirement age, you have the income you need to pay your expenses and live comfortably.
When Should I Start Saving for Retirement?
One of the questions we hear most often from our younger members is, “when should I start saving for retirement?” We love this question because it gives us an opportunity to provide guidance to help people avoid common retirement planning mistakes, such as waiting too long to prioritize retirement savings.
The short answer is that you should start saving for retirement as early as possible. The earlier you start, the sooner you can take advantage of continuous compounding interest to grow your savings. It’s not enough to put money into a savings account, although we’re certainly fans of creating an emergency fund and having money that’s accessible when you need it.
Retirement planning requires managing your money to prioritize retirement savings. As life expectancies increase, it becomes more likely that people will outlive their savings. Very few of us would be able to live comfortably on our Social Security income alone.
If high inflation has taught us anything, it’s to expect that we’ll need more retirement income than we think. In 2024, groceries are 25% more expensive than they were in 2020. That’s a huge increase and something that should give all of us pause.
How Do Employer Contributions to a 401(k) Work?
The most common type of employer-sponsored retirement account is the 401(k). If you work for a company that offers a 401(k), our first recommendation to jump-start your retirement savings is to enroll in the 401(k) as soon as you’re eligible and max out your contributions if financially possible.
In 2024, the maximum individual contribution to a 401(k) plan is $23,000, with a catch-up contribution of an additional $7,500 for people over 50. Many large companies offer employer matching of contributions up to a set limit, which is often 6% of the employee’s gross salary. The $23,000 limit does not include employer contributions. When you sign up for a 401(k), ask about employer matching contributions. We recommend contributing, at minimum, the maximum percentage your employer will match.
Keep in mind that traditional 401(k) contributions are made on a tax-deferred basis. You’ll pay less in taxes now because your contributions will be deducted from your paycheck. The trade-off is that you’ll pay taxes on withdrawals in retirement (there is an option to structure a 401(k) as a Roth account, in which case you would contribute on a post-tax basis).
What Are the Differences Between Traditional IRAs and Roth IRAs?
It’s permissible to have more than one type of retirement account. If you want to accelerate your retirement savings, or if you don’t have an employer-sponsored retirement account, you may want to consider an Individual Retirement Account, or IRA. There are several types to consider.
Traditional IRA
A traditional IRA is a tax-deferred retirement account that shares some similarities with a 401(k). You can make pre-tax contributions from your paycheck, and if you contribute on a post-tax basis, you may be eligible for a tax deduction depending on a variety of factors. You can read the IRS rules here.
In 2024, the maximum individual contribution to an IRA is $7,000 and there’s a catch-up contribution of $1,000 for people over 50. You will need to pay taxes when you withdraw money from your traditional IRA.
Roth IRA
A Roth IRA is an IRA where contributions are made on a post-tax basis. That means you won’t reduce your taxable income or get a tax deduction if you open a Roth IRA. What you will get however, is tax-free growth and withdrawals.
The maximum contribution to a Roth IRA in 2024 is the same as for a traditional IRA: $7,000 with a catch-up contribution of $1,000. The primary benefit is that you won’t need to worry about paying taxes when you withdraw money from your account.
SEP IRA
A Simplified Employee Pension or SEP IRA is designed for those who are self-employed or gig workers who have income from side jobs. For a long time, SEP IRAs were only available as traditional IRAs, but as of 2023, there’s a Roth SEP IRA option, too.
The biggest difference between a SEP IRA and Traditional or Roth IRAs is the contribution limit. As of 2024, individuals may contribute a maximum of $69,000 or 25% of their total compensation, whichever is less.
Term Share Certificate IRA
A term share certificate IRA is like a retirement CD. You put money in and choose a term. Your money earns dividends or interest over the term. Our Addition Financial term share certificate IRAs have terms from six months to five years.
Contributions may be made on a pre- or post-tax basis, but there are penalties for early withdrawal. You have the option of setting up tiered terms and reinvesting money when the term is up, which you may want to discuss with a financial advisor.
What Are Some Other Retirement Saving Options Besides IRAs and 401(k)s?
If your financial goal is to save enough for a comfortable retirement, you may be wondering if there are other retirement saving options available. Here are a few to consider:
- Solo 401(k): These accounts are available for business owners with no employees (other than a spouse.) The contribution limit is the same as for a SEP IRA.
- 403(b) or 457(b) plans: These work like 401(k) plans but are available only to employees of public schools, colleges, non-profits, churches and municipal, state and federal governments.
- Health Savings Plans: These are available to those with high-deductible health insurance. Some employers offer matching funds. You won’t pay taxes if you withdraw funds for qualified medical expenses. Once you’re 65, you can avoid the 20% penalty and use the funds for anything you want. Of course, you can use them for medical expenses such as long term care.
- Taxable brokerage accounts: Accounts that are exempt from contribution limits, but are taxable. You’ll need to pay capital gains tax on your earnings. If you’ve already maxed out your 401(k) or IRA contributions, a brokerage account can help you reach your retirement savings goals.
- Life insurance: This can play an important role in retirement planning, particularly if you have a spouse or dependent children. You can buy tiered term life policies or a whole life policy and assign beneficiaries. The proceeds can help them pay for expenses after you die.
- Employee Stock Ownership Plans: Or ESOPs are not retirement accounts in the strictest sense, but they can provide money to support you in retirement. You don’t need to contribute anything and you can get access to the stock when you leave the company or retire. Your employer is legally required to offer you a fair price to buy back the stock.
- Annuities: A type of insurance that can be used to provide either lump sum or monthly payments in retirement. A cash-balance defined benefit plan is an employer plan that is a type of annuity. You can also purchase annuities. They don’t offer the highest growth when compared to investment accounts, but they can provide financial stability and act as a supplement to other sources of income.
We should note here that 403(b) and 457(b) plans are subject to the same contribution limits as 401(k) plans and may be offered as traditional or Roth accounts.
How Much Do You Need to Save for Retirement?
One of the most important things to know as you plan for retirement is how much money you’ll need to save to live comfortably. There are many factors to consider, including when you plan to retire, what you want to do and what your income is at retirement.
It’s possible to calculate the amount you’ll need to save by starting with your monthly withdrawal needs and an estimated number of years for your retirement. Our free retirement savings calculator can help you with the math and with setting a long-term retirement savings goal. You can also use a simple formula to calculate the total amount you’ll need to save; take your desired annual retirement income and divide it by 4%. For example, if you wanted $85,000 in annual retirement income, you would need to save $2.125 million.
Start Your Retirement Planning with Addition Financial
Whether you’ve already got a retirement account or you’re just getting started, it’s important to remember that the sooner you make retirement saving a priority, the more likely it is that you’ll save enough money to have an enjoyable and comfortable retirement. The account information and advice we’ve provided here can help you learn how to prepare for retirement and create retirement savings goals.
Do you need assistance with retirement planning? The MEMBERS Financial Services program can help you. Learn more and make an appointment with one of our Financial Professionals today.
Posted on Mar 14, 2024
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