It’s a pretty familiar story. A person doesn’t pay any attention to retirement savings at the start of their career, deciding usually on the spur of the moment that it’s not really something they need to do right now. Usually, it’s not even thought about as something they should do “someday,” as it isn’t even considered that deeply. It’s just something that people think of as irrelevant in that moment.
Eventually, though, little things keep popping up in their life that directs their attention toward retirement savings. Maybe they’ll hear about their parents or the parents of a good friend struggling in retirement. Maybe they’ll keep reading news stories about retirement. Maybe they’ll see a Social Security benefits statement in the mail.
And, eventually, those little things add up to enough weight to flip that switch. They’ll start thinking about retirement on their own. They’ll maybe do a Google search or two and get all kinds of crazy answers.
And they’ll start to worry.
If that sounds anything like you, then you’re the exact person I’m talking to here. You’ve finally come to the realization that you might have to save for retirement and it’s frankly a bit overwhelming and scary and perhaps feels a bit unrealistic.
Let’s dig in to the most common questions people tend to have at this point, questions that many other readers have brought up over the years when at this very crossroads.
Why Do I Have to Save When My Parents Did Not?
Part of the reason that many people choose not to save for retirement is that it’s simply not something their parents had to do. Many children of baby boomers and even some children of older Generation Xers had parents who were lucky enough to have pensions provided by their employer.
A pension is a really wonderful thing. It’s an additional benefit employers offer their employees that guarantees them some income for life after they retire, usually based on years of service to the company.
Take my father, for instance. He worked for the same company for around 35 years, even through some tough years in the 1980s where layoffs were frequent. His reward for that loyalty was a pension that supplements his Social Security in the form of a check that arrives every month from his old employer.
On the other hand, very few employers today offer those benefits, especially to people my age. Some government agencies offer such pensions, but aside from that, they’re awfully rare.
That’s why many people in their thirties and forties and fifties today have parents that didn’t have to save for retirement — but that same benefit doesn’t apply to them.
Why Save When Social Security Exists?
Isn’t Social Security designed to ensure that people are going to be okay in retirement? It’s a nice theory, but it doesn’t reflect reality for two big reasons.
Reason #1: Social Security Benefits Alone Will Likely Not Support the Kind of Retirement You Want
The reason that many people’s parents have been able to have stable retirements isn’t because of Social Security. It’s because of a healthy pension (or other financial choices they’ve made). Social Security benefits alone simply aren’t enough for people to have the kind of retirement they envision.
Take a look at this Social Security calculator. Let’s say you make $40,000 a year at your peak and retire at age 65. Your benefits are going to only be $1,129 a month. That adds up to about $13,400 a year. Ouch.
Even if you hang on to age 70, your Social Security benefit is only going to be $1,658 a month which doesn’t quite add up to $20,000 a year. Again, ouch.
If you live a very careful existence, those benefits (with cost of living increases) will be able to allow you to survive and keep food on the table, but there won’t be much breathing room at all, and the cost of health care will be crushing. It just doesn’t add up for most people and the lives they want to live.
Reason #2: Social Security Will Have to Change in the Future
The long-term math for Social Security is on shaky ground. Exactly how shaky depends on which reports you read, but most of them tend to agree that the whole system is going to run into some difficulty in the future, as there will be fewer people putting money in and more people taking money out.
What will that mean for you? It’s really hard to tell because it depends entirely on which way the wind is blowing when the system begins to run into trouble in a decade or two. They may increase the costs for people paying in. They may also cut benefits. It’s impossible to say for sure.
Regardless of what happens, depending on Social Security as an absolute guarantee is likely a mistake. You should make plans that allow you to survive even without Social Security.
Should I Retire At All?
This is a question that many people eventually start asking themselves.
Some people come to the conclusion that they’re simply going to keep working at their current job until they are unable to do so, foregoing any sort of “retirement golden years.” This is essentially what my mother-in-law and father-in-law are doing, as they are traveling extensively during their fifties and sixties and using their time off from work to the fullest.
Other people plan on using their retirement for another career, one that will theoretically earn at least some money to supplement their Social Security.
Even if this describes you, having at least some money socked away for those later years will be beneficial. There’s no guarantee that you’ll have your current job then or that it will be stable when you’re in your sixties or seventies. And your employment options and income options may be limited — to say nothing of an unexpected health issue that could prevent you from working in your later years.
Retirement savings can make the difference here, even if it’s not enough to fully support your lifestyle.
What Are My Options for Saving for Retirement?
One of the big challenges for people when it comes to saving for retirement is that there are a lot of options out there. I’m going to list six common options below, ones that I often see and hear people using, but they are just six among a nearly infinite number of plans.
Option #1: A Savings Account
I consider the option of putting money into your savings account to be the “default” option. It works to an extent in that it will keep your retirement savings very safe and at least earn a little bit of a return, but it has some really big drawbacks.
First of all, you don’t get a very good return on your money in a savings account. Savings accounts rarely pay out more than 1% these days, and those that do usually have big restrictions on them. Compare that to the 7% annual rate of return that you can realistically expect to get in other investments. Over time, that ends up being a very, very large difference.
Second, there isn’t any tax benefit here. Let’s say you have $100,000 in a savings account that earns 1% interest. Over the course of a year, that savings account will earn $1,000 in interest, but at the end of the year, you’re going to have to pay taxes on that interest. That might be a pretty painful thing, as you might end up paying as much as 39% of the interest away in taxes. With better retirement planning, you wouldn’t have to pay taxes on any of the gains.
The one big advantage of a savings account is that it is insured by the FDIC against the failure of your bank. You’re not going to lose that money. Still, you can get a very similar insurance against business failure in other investment options.
A savings account is better than nothing at all, of course, but it is far from your best option.
Option #2: An Investment Advisor
The next option that many people consider is just going to an investment advisor. They’ll look up the number of their local Edward Jones office and stop in, explaining their situation to the advisor there and letting that person make the choices.
Any investment advisor worth his or her salt will likely set you up with an IRA of some kind, likely a Roth IRA. However, that’s something you can actually do for yourself without paying an investment advisor to be a middle man. (I’ll describe that more below.)
Not only that, some financial advisors (especially ones that operate on commission) have strong financial interest to guide you into certain investments, ones that might not be best for you but earn a lot of money for the investment advisor. Those investments generally aren’t bad (at least if you’re with a reputable advisor), but there are usually very similar investments out there that offer better returns.
So why would you talk to an investment advisor, then? Often, financial decisions can seem really scary and people get a sense that if they make a misstep, they’ll end up costing themselves far more than what they would have to pay a financial advisor for. It’s comparable to having someone who knows nothing about plumbing being handed a pipe wrench and told to install some pipes. Even though the task really isn’t that hard, the perception of difficulty and the visions of the disasters that could occur is often enough to warrant calling in an expert.
Personally, I think that there’s more benefit in figuring out enough of what’s going on to just manage retirement savings yourself. It’s really not that complicated. Once you learn about some of the details of retirement savings, the decisions really aren’t that complicated.
Option #3: Investing on My Own in Taxable Funds
Some people will simply open up a brokerage account and start putting money in there regularly.
A brokerage account is simply an account that you have with an investment house (like, say, Fidelity or Ameritrade) that will help you with the nuts and bolts of doing things like buying stocks and bonds. You deposit money into that account and then you’re able to use that money to do things like buy stocks and bonds and, later, to sell them to hopefully earn a profit.
If you want to buy a share of stock, for example, the brokerage helps you to find someone that is selling that share and makes the trade for you. They usually charge a fee of some kind for that service.
Investments like these open the door to much higher returns than a savings account, of course. For example, the stock market tends to return an average of 7% per year over the long haul (that percentage is higher or a bit lower depending on how you count).
There are a few problems, though. One is that there are brokerage fees to deal with, which can chip into your returns. This has less of an impact on people who simply buy investments in big chunks every once in a while and sit on them, which is a very sound strategy. But if you buy frequently and sell a lot, it’s going to really hurt.
Another problem is the taxes, as discussed above with savings accounts – every dollar you make has tax consequences and it can get pretty challenging and confusing if you buy and sell a lot. If you’re saving for retirement, you should take advantage of some tax benefits that are available for people in your boat, and I’ll discuss those below.
Yet another problem is that there’s no guidance. A typical brokerage account is akin to being thrown into the deep end of the swimming pool with no life preserver. If you don’t know how to swim in there, you’re going to thrash around and make mistakes. There are a lot of investment options available – many good, some pretty poor. Most brokerage accounts do very little to help you figure out what you should be investing in. They leave that up to you to figure out and it’s easy to pick something that’s a decent investment, but maybe not the best choice for you and your situation.
Option #4: Buying Real Estate
One of my relatives used this as his retirement plan. All through his life, he slowly bought up properties in his area and eventually retired, living off of Social Security and the rent he was charging on those properties.
He paid for the houses he purchased with cash, but many people go down this route by taking out mortgages for the properties and earning the money back through rent which goes to pay for the mortgages.
This has a couple of nice benefits. For one, you’ll be earning a return on your property without selling it provided you’re charging rent to someone using that property. For another, you’re likely to be holding onto that property at least until retirement where the taxes on that sale will have a much less painful impact (because your tax rate will be lower when you retire, since your overall income is lower).
Again, one drawback of this plan is that there are no other real tax benefits, but compared to the other plans you really don’t need them nearly as much. It’s unlikely that you will sell the houses until you reach retirement age anyway, if ever.
Another drawback is, well, you have to manage the property yourself. That means that you’ll either be devoting some of your free time to maintaining the property (and paying for any maintenance) or paying a property management company to do it for you.
There are also some real expenses and risks. You’ll be paying insurance and property taxes on top of any mortgage interest, which can really devour your gains, especially if you don’t have someone renting the property.
This can work, but it works best when you can afford to take on some risk and things aren’t going to fall apart if you don’t have tenants for a while.
Option #5: A 401(k), 403(b), or TSP Through My Workplace
Here, we get to some really good retirement options. This group of options focus on plans offered by your workplace – usually a 401(k), 403(b), or TSP, but there are other flavors. They all work roughly the same way, though.
With an account like this, you sign up through your workplace and agree to have a percentage of money taken out of your paycheck. Most of the time, that money is taken out before taxes, which means that your paycheck won’t go down as much right now but you’ll have to pay taxes on that money when you withdraw it in retirement.
Sometimes, particularly when you have a “Roth” offering, the money is taken out after taxes, which means the money comes straight out of your take-home pay, but you won’t pay any taxes on that money (or investment gains) in retirement.
This is really convenient because you just don’t have to worry about actually saving. Your employer handles the mechanism for you – once you’re signed up, there’s nothing you need to do any more.
Another benefit is that some employers offer matching funds on your contributions. I’ll make this very clear: If your employer offers matching money in your 401(k) or 403(b) or TSP, this is the best way to save for retirement.
There’s nothing else that will compare to it because it’s basically fistfuls of free money in your retirement savings. Free money isn’t something that happens in life very often, so you need to grab this. Contribute at least enough to get every single drop of matching funds, period.
It’s also usually pretty easy to choose investments within this account. That’s because many such accounts usually just offer a handful of options to choose from – target-date retirement accounts (which are usually a really good option) and maybe a few others.
What’s the drawback? The investment options in such an account are often good but not great. They tend to not be terrible, but they are usually chosen to make some money for the company that runs the 401(k).
In general, this is far and away the best option for retirement savings as long as there is any employer matching available. If your employer offers matching contributions, your first step is easy – go sign up for the retirement plan at work and gobble up every single drop of matching money that you can get. If they match up to 6%, contribute 6%. If they match up to 10%, contribute 10%. You’ll be giving yourself a raise.
Option #6: A Roth IRA (or Traditional IRA)
But what if your employer doesn’t offer a plan, or what if they don’t offer any matching within that plan? In that case, an IRA is probably your best choice.
An IRA is kind of like an employer-sponsored plan as described above, except that no employer is involved. Instead, you have to sign up with a company that offers IRAs (there are many – I personally use Vanguard) and open that account yourself.
That’s a big step for some people, but it’s not actually all that tough. To get money in there, you usually have to sign up to have money taken out of your checking account and deposited into that account, which will all be set up during the account sign-up process. Then, in the future, money will be automatically moved from your checking account to the IRA on a regular basis.
There are two different kinds of IRAs. Roth IRAs are the best option for most people, as they’re available for everyone making under six figures a year (and even some people a little over that, too). In a Roth IRA, you contribute money straight from your checking account, but once the money is in there, you basically never have to pay taxes on it again. You can take out the money you contributed whenever you want without paying taxes or penalties, and if you wait until age 59 1/2, you can take out any money you earned in that account without paying any taxes on it. It’s income without taxes! (The other kind of IRA is a “traditional” IRA, which is an option for people with higher incomes.)
The biggest drawback of IRAs is that there are a lot of options. Unlike a 401(k), you have to choose an investment house first (as I said earlier, I use Vanguard) and then, once you’re signed up, you usually have a ton of investment options. The easiest route for most people is to just use a target-date retirement fund that matches the year you hope to retire.
I Am Scared to Sign Up! What If I Make a Mistake?
The one thing that holds people back from signing up for a retirement account is the fear of making a mistake that’s going to end up costing them more in the future. Part of that fear comes from an investment industry that wants people to hire financial advisors for everything, so they try to make investing seem intimidating and scary. It’s not.
Here’s the truth: 99% of the success and failure of saving for retirement comes from how much you choose to save, not the exact place you choose to put it.
That’s especially true right at the start, as you don’t have much in there to really be affected by stocks or real estate going up and down in value. You can always move things around later on. The best ticket to retirement savings success isn’t choosing the right investment or the right brokerage. It’s choosing to save as much as you possibly can.
My very simple recipe for retirement savings success is as follows:
- First, find out if your employer has a retirement plan available for you and, if they do, whether it offers matching on your contributions. If it does, sign up for that plan. Choose the Roth option if it is available to you, as that tends to be better for taxes for those who are eligible for it.
- If your employer doesn’t have a matching plan, sign up for an IRA – again, preferably a Roth IRA if you’re eligible for it – at a investment house. I use Vanguard but, honestly, none of the major ones are really bad – they just tend to vary in the amount of fees and hand-holding they provide. Fidelity is definitely a good option, too.
- When signing up, contribute as much as you reasonably can to that account, and choose a target-date retirement fund that’s close to your retirement year as your investment.
- Then, let it sit. Every once in a while, consider contributing more than you already are if you can do so.
You pretty much can’t go wrong with that plan. If you follow it, you’re going to be on the right path with retirement savings without making any big mistakes.