New Year’s Resolution Workshop #1: Get Started with Retirement

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new year's resolution workshopOver the next few days, we’re going to take a look at five common New Year’s resolutions that people often adopt for their finances, evaluate some of the traps that people fall into with regards to that resolution, and come up with some real actions that can turn a challenging New Year’s resolution into a success.

Retirement planning is one of those painful things that we all know we should be doing, but for those of us who started our careers with a routine of not saving for retirement, it can be a painful subject to consider. Yet another drain on my current paycheck? It doesn’t sound like something that many of us would look forward to.

Because of this tug-of-war between a recognition that we need to save for retirement as opposed to a desire to maintain as much take-home pay as possible, people often resolve to make the coming year one where they finally take charge of their retirement planning, but often it’s a resolution that falls short. They find little things standing in their way and use that as a reason to not take control of the situation.

No more. If 2009 is going to be the year when you take control of your retirement, you need a plan. Here are some simple steps you can take to get a retirement plan in place for yourself, no matter what your situation is.

First, find out if your place of employment offers a retirement plan. Likely, you already know this – if you don’t, contact your supervisor and find out who you can contact to find out more. Many workplaces offer some form of a 401(k) or 403(b) retirement plan which is very easy to participate in.

If you do find that your place of employment offers such a plan, get signed up as soon as possible, even if you’re unsure how much you will be contributing to the plan. You’re better off getting the plan in place now, since you can change your contributions later on. Actually signing up for the plan should also be straightforward – if you need help, ask for help from the person who gave you the forms.

How much should you contribute? This is the stumbling block that catches many people and keeps them from actually pulling the trigger. They consider contributing 5% to a 401(k) plan, but when they envision their paycheck dropping by that much, they don’t even want to think about having to deal with that kind of pay cut.

First of all, your paycheck won’t actually drop that much. For example, if you contribute 5% of your paycheck to a 401(k) or a 403(b) plan, your take-home pay will only go down 3 to 4%. Why? The 5% is taken out before taxes. Let’s say you earn $10 an hour, earning $400 a week, and 25% of that is eaten up by taxes of various kinds. That leaves you with a $300 paycheck at the end of the week, right? Well, let’s say you elect to contribute 5% of your pay to a 401(k) plan. You earn $400, then 5% of that is taken for the plan, leaving you with $380 in pay and $20 contributed to the plan. Then, 25% of that is taken in taxes, leaving you with a take-home of $285. You were able to contribute $20 to your retirement, but your take-home only went down $15. (In fact, it might even be better than that, because likely you’re going to have slightly less of your check taken out in taxes, but that’s a much more complicated story.)

Second, the reduction in your paycheck will be easier to handle than you think. Whenever a person’s earnings fluctuate a bit, their spending almost always automatically fluctuates to keep pace with it, and it’s often not noticed at all. In the example above, the $15 difference in paychecks would likely quickly evaporate in the form of different food purchases, for example.

So, how much should you contribute? For most people, 10% is a good number to target when you’re first starting out. Some employers actually match your contributions, so you can include their matching in that 10% – if you contribute 5% and they match 5%, there’s your 10%. If you’re over 30 and you haven’t started yet, you should look at a bit higher number – 12% or 15% might be better for you.

Even if the percentage seems painfully high, give it a try and see how it works. You might find that it’s easier to deal with than you think – and if it’s not, you can always request to lower your contribution percentage.

What if I don’t have a 401(k) or 403(b) option? Your best option is to start a Roth IRA, which is an independent retirement plan you can easily set up yourself. I recommend using Vanguard to manage it – that’s the group I use. You’ll have to make contributions to this plan directly from your checking account – I have a small amount withdrawn each week for my Roth IRA. They do all of this automatically for you – you only have to set it up once, then you can forget about it.

How should you invest the money? For most people, the easiest solution is to simply put all of one’s contributions into a “target retirement” fund. Most retirement plans offer several of these target retirement plans, which are intended to automatically manage your money over time, helping you get big growth early on, but slow down and become more stable as you near retirement. Pick the one with the year that’s closest to when you turn 65 – for example, if you’re 25 in 2008, you’ll be 65 in 2048, so you should choose a Target Retirement 2045 or 2050 plan. If you don’t have a “target retirement” plan, go conservative. Put 50% of your contributions into one of the stock options (preferably whichever one is the broadest one) and 50% into one of the bond options (again, whichever one is the broadest). This is a pretty conservative choice, but it will keep your money fairly safe no matter what the future holds.

The bottom line is to just take that first step. Even if you’re not contributing much at first, at least you’re setting up the plan and making a start at things.

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26 thoughts on “New Year’s Resolution Workshop #1: Get Started with Retirement

  1. Nice article.

    Many people are unfortunate to be retiring in this awful economy, but this article helps the people that have a job a retirement guide.

  2. I’m 19 years old and just opened a Roth IRA on December 24… I’m so excited about it! I can’t fully fund it this year (didn’t make enough working part time), but I will be able to fully fund it next year.

  3. Sara~ good for you! No, GREAT for you! I’m 45 and opened two Roth IRAs this year – one for me and one for my wife. I wish I had had your foresight when I was your age! Do you realize what $4000 a year will add up to in the course of your lifetime? WOW!

  4. trent,
    You have the best frugal website out there. Thats a fact. I have been following you for 2 years. Guess what? I’m done. Dont get me wrong, I’m not done following you, but I’m done. I have used up every dime I have to transport my 2 year old to montessori school. I am slowly slipping into debt. But, as I have said to his mother, if my mother will dish out $10,000 a year, for the best education my only child will receive, then I will do anything to get him there. You see his grandmother is wealthy. His private school until college is paid for. She has garunteed it. I simply need to get him there. Its a 1.5 hour trip daily per 5 days a week. ( 45 minutes one way, simsbury CT ) Pro: He loves it.
    Con: stress of driving, gas money.
    Pro: Not many kids get this chance.

    So….I will simply get more and more in debt for the benefit of my sons education. I dont want him to scrape by like I do.

    I am willing to sacrifice.

  5. Rob:

    There is no pressure on that kid to perform. I am sure he will be thankful for parents who went broke to send him to a school that in the end really doesn’t matter.

    Trent.

    Like the blog, however…:)

    Your advice regarding retirement investing follows many others opinions yet little mention of risk is included.

    The reason stocks historically perform better than bonds and treasuries is because they have a greater risk. Today’s climate is a reminder of that risk and how real it is.

    Stocks are not on “sale” right now. That is sales propaganda and media laziness. They are simply worth less. There is a reason why. Advice to blindly invest in “target funds” which is essentially telling people to invest in something they know nothing about and leave it to the “professionals” is interesting. You don’t need to pay a professional a 1% fee to loose you 40%. That is what millions of people are doing as we speak. Yet they have the “faith” that things will turn around. They have been wrong. They are likely to be wrong again.

    I also enjoy the “invest at least as much to get the company match…it is free money” line from other posts.

    It isn’t free money, it is calculated and factored in with compensation. Also, just because it is accessible doesn’t mean it should go into retirement.

    The last 10 years the S&P 500 index return has actually lost money. Down about 1%. Even with the company match, it is not always the best advice. For those lucky people who had invested within the past decade and are nearing retirement, investing in stocks inside their retirement plan with a company match just made them loose MORE money.

    A sound strategy is to invest in what you understand well, whatever that is. Stocks, bonds, metals, real estate, futures, commodities, classic cars, etc.

    If you don’t understand where you put your money, the reasons for doing so become irrelevant.

  6. Oooh, what a GREAT post! I can’t wait to see the rest of this series!

    Thanks again for your great blog, Trent. Thanks to you, in the past two years, I have really become focused on knowing where EVERY penny of my money goes, and in doing so, I am more cognizant of saving more agressively towards retirement. Im fortunate, I dont have ANY debt, and I own my home . . . so my focus is to concentrate on beefing up my emergency fund and to fully financing my retirement every year through contributions at work and private ones to my ROTH.

    Thanks SO much . . . and again, looking forward to this series of posts!

  7. I love reading posts like these. There was a book that came out a few months back called The New Retirementality, or NR. Of course NR = New Rich and that can be interpreted in a number of ways.

    What gets me smiling the most about posts like this one is that while most of the readers here are people in their 30s, 40s and up, younger folk like myself have a serious “ball in our court” by taking financial action toward our retirements now…much more than ever.

  8. Trent, you are providing a great service. I apologize in advance if you have already breached the subject. Self-Directing your IRA is another way you can diversify your accounts. Take a look at http://www.IRAvestor.org for more info. The site is free and it meant to help people educate themselves.

  9. @ Rob

    I think you may be over-emphasizing your child’s education as odd as that may sound. There are plenty of examples of children excelling in average academic environments. As someone who is married to an educator, there is no proof that an elite education at the pre-school/grammar/high school level guarantees any special success for a given child.

    What you can do is create a good learning environment at home and be involved in your child’s education every step of the way. Do what you can for your child’s education, but I would certainly advise that you do not get in debt over Montessori school.

    Good luck.

    Best,
    http://www.scordo.com/blog/blog – a practical living blog

  10. I’ve been saving almost obsessively for my retirement for a few years (I’m in my 40s) and have it set up in my budget to save even though I just decided to go self-employed this year.

    I hadn’t, though, been saving for my children’s college. I decided to start with automatic deductions from my checking account into a Vanguard 529. I thought it would be painful, but once it’s deducted automatically I just don’t count on that money any more.

    I suggest starting with at least $5 or $10 then keep uppping it when you notice that it’s less painful than you thought.

  11. I’m really looking forward to this series, Trent, and I think it’s really smart. I have one note–you suggest that those without a 401K or 403b open up a Roth IRA, but you don’t mention that a Roth isn’t tax-deductible. Given your encouragement that “your paycheck won’t drop that much,” you should make it clear that it will with a Roth IRA.

    I personally have a Roth IRA and I prefer it, because of the idea that withdrawals will never be taxed (assuming the gov. doesn’t renege). However, readers should know that they can also open a Traditional IRA with Vanguard, which functions in the same way as a 401K–is that correct?

  12. Hi Trent,
    I am looking forward to your series. I think having
    money saved just gives you a feeling of security for the future.
    I think an emergency fund also is important to have. I am going to be working on these two things.
    Those are my thoughts. Happy New Year!!!! Thanks for making me think about all the things you post about.They are all good topics. I learn also from
    the people who commented before I did.

  13. Rob,

    While I know your heart is in the right place, you need to consider your son’s future as it relates to your own.

    If he gets a GREAT education and a fantastic job, but also has to support you because you were unable to save for retirement or get out of debt, how is he better off? I know you don’t want him to struggle to make ends meet, but be careful that you don’t become a burden yourself. Besides, will a top-quality education necessarily lead to success? Sometimes, but not always.

    Have a talk with your mother. If she is willing to pay $10,000 per year regardless of what school he attends, maybe you could find a high-quality private school close to home. Have you also looked into other public or cyber schools? I come from a small town, but we have several options available to us – and if your public school doesn’t meet state guidelines, you may be able to transfer to another district.

    Maybe if you could find a less expensive school, your mom could stash some money away for college. $10,000 seems to be a lot for primary school…

    Good luck! Best wishes in the new year. :)

  14. Trent, looking forward to the posts. However, I’m a bit confused. If I put money into a Roth IRA, isn’t it taxed up front compared to a 401k or 403b? Wouldn’t it be more intelligent, tax wise, to put the money into a normal IRA instead? Please let me know if I’m incorrect because I’d really rather use a Roth IRA.

  15. One of the advantages of working at a non-profit is how much they contribute in matching funds. My company gives you 5% up front and then matches your contributions up to 5%. I am saving 15% of my annual salary. Of course, a non-profit does not pay as much as a for-profit company, so it might all work out in the end.

  16. Trent – maybe my history will be of use to others. We were always deep in debt & I didn’t start saving in the state’s 457 plan until I was about 50. We were $34-35K in cc debt only. I was working away from home & doing 2-3 jobs or more.

    Finally I realized that we were scraping by on what we were paying and so I decided to have my raise that year put into the 457. I knew I could change that figure if necessary. Well, bless my soul, I went in one year to tell them to put my raise in. They told me I couldn’t. I could only put $11 a month in this year. Why? Apparently I was now at their limit of 25% of my gross income. I was flabbergasted. I had never been able to save that much.

    In that 17 years for the state & my other jobs, I paid the expenses at home & in town where I had to live close to work-with my husband’s help, paid off the entire cc debt, and had put $50K of my own money in my retirement. I was over the moon. Reiterate to people how easy it is to save, especially when it is taken out before you get it. I only have about 1/15th of what people say I should have, but with SS & 2 small retirements, I need only take out the minimum each year. I can use it to fix up my home or save it.

    The other smart move we made at retirement was to take a small cut and insure that the retirements would go 100% to surviving spouse. When my husband died in 9/07, my retirement went back up to normal and I am receiving his.

    I did not ever expect to get any retirement because of the health and life insurance premiums and taxes. (My husband had cancer for 8 years and that insurance was essential.) However, my first retirement amount showed me getting $109. Since I had not planned on that, I put $100 automatically into Emigrant-Direct. When husband died, my insurance went down $200. That also went straight to E-D.

    I am still saving because I know that, even though I am doing satisfactorily now, higher costs will come and I will need the savings. For not being a saver in my lifetime, I am holding a good emergency fund, a fair amount of 457, own my home and have the ability to live normally.

    Please keep repeating the idea of saving automatically. It really works. I can testify to that. Just wish I had known of you earlier, but I doubt this blog was around then. I started saving in 1987.

  17. Rob,

    DITTO what Stacey wrote! Chances are good that there are options for your child that would be equally positive with lesser cost to your security.

    Thank you for this amazing topic, Trent

  18. @Rob:

    I am guessing that transportation can be viewed as a cost of education. Perhaps Grandma could provide a school transportation stipend for your daughter as well, since it is clear that you cannot afford the cost of it.

    Of course, there are other options like switching to a close school, as well.

  19. Georgia, thanks for your comment. It’s great to hear from people who have really lived and succeeded using these ideas. I wish I had started earlier too, but I feel great about my progress this year. By retirement, my house should be paid off and even though I won’t have a million or more in the bank, I should be able to support myself on my retirement, my 401k, my savings and whatever Social Security I may get. I’m feeling good about the future!

  20. This is exactly what I tell all those new grads starting out. They’ve got no clue how important and easy saving for retirement is in one’s early 20′s.

  21. Rob,

    I simply cannot believe that one school for a 2 year old would be so much better than another that it would justify such a blow to your financial situation, let alone the tuition payment. I didn’t even start preschool until I was almost 4, and I think I turned out all right.

    The very best sacrifice you can make for your son’s education is not sending him to a fancy private school, but providing a supportive environment for him in the home. Read to him and talk about what you’ve read. Have stimulating toys and games (not necessarily expensive ones) for him to play with. Take him to age-appropriate museum exhibits. When he’s older, make sure he has a time and a place to do his homework and study for tests. Talk to him about his ambitions, and help him discover what he needs to do to get on the road to achieving them.

    The reason why private schools, charter schools, and magnet schools have records that are so much better than run-of-the-mill public schools is not necessarily that the teaching is so much better, but that they are full of students whose parents care about their educations. Students at public schools whose parents care about their educations also do well (as long as the schools are not downright bad, which some are, but most aren’t).

  22. I can understand the desire for a Montessori school, but is this the closest one? I think that if your mother is insistant on Montessori, that you could find another one closer to you.
    What about carpooling? Screen as carefully as you would a nanny, do fingerprints…but even if you drive 10 minutes and then they drive your child the other 35 that is almost an hour saved and half the gas of that hour.
    Look at the car you are driving. Down-sizing the car would cut the gas cost signifigantly. Gas prices have dropped by half, are you still hurting for money? If not, try to stash some of that extra into a fund for when gas is higher.
    When your child is older is there a train he can take to school? Is it a safe option? If so you can look at it as a temperary problem…for ten years or so, and plan accordingly.

  23. I started saving with my first job out of college (6 years ago : Age 22). Even though it’s been hard to watch my 401k go down 35% this year, I keep reminding myself that those losses are cutting into the PROFIT I’ve received over the past 5 years of investing and the money my employer has put into the account for our yearly profit-sharing (3-5%).

    I am in this for the long haul. I had to reduce my contribution earlier this year due to some financial issues, but raised it back to 5%. I was affraid that the extra 3% would really take a bite out of my paycheck. It didnt… barely at all. I look forward to getting my contributions back up to 10% here in the next 6 months. If you do it little by little, one percent at a time, it doesnt hurt nearly as bad.

    For me, it’s easier to put save if I dont see it. I would like to do a Roth; however, I tend to find other things to use the money for if I have it in my bank account.

    To each their own.

  24. Rob: I looked at the school’s website. It looks like a nice school. But I’m still not convinced that it’s such a nice school that it’s worth going broke over.

  25. The hardest part is getting started. Once you get past that barrier, and start actively saving, becoming more efficient and more content with it becomes a lot easier.

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