What it is.
For the most part, it’s getting out of the workforce. At least stepping out of your main career and into something less demanding, which generally translates into a job that pays less—much less or even nothing like volunteering. A very interesting look at the history of the notion of retirement is this article from Pre-Y2K.
We haven’t been kicking around the idea of retirement for very long. Now that more of us are keeping on keeping on, though, well, it’s become the dream. Retirement. A period of life when you can BYOB (be your own boss). No one controls your time but you. And probably that little dog you own from what I’ve seen. You can travel the country or hop around the globe. You can pen your memoir and if you find out it’s boring, you can embellish it. Make it a fantasy and write fan fiction on what your life might’ve been like if you were secretly a spy or the Zodiac killer. Remodel your house. Remodel it again. Throw yourself into art. Spend your summers by the lake and your winters in the hot springs. Red hat society. Endless brunch. Netflix forever.
Maybe that’s not your dream of retirement. Maybe yours is a little more noble. Finally have the time to volunteer. Mentor a child—not one related to you. Start a community garden. Find a way to help those with the greatest need, say by volunteering to watch a single parent’s kids a couple of days a week. Okay, at least one day a week. Become an advocate. Serve.
That’s the dream. Of course, the dream usually leaves out some of reality. Like the reality of healthcare costs. Medicare Part A is free. Part B has a current cost of about $110 a month. That doesn’t cover everything, though. So, you’ll have to cover a supplemental policy or else fork over medical expenses out of pocket. Do you have prescriptions? Now there’s a Part D to cover. What about dental? Can you even find a policy for that? All the work you need done in your 40’s will need to be redone. That can add up to over $10k. And what if you want to retire early? How are you going to pay for your health insurance premiums until you make it to the qualifying age for Medicare? Maybe now you realize you can’t afford to retire until you qualify.
And there’s still all the normal everyday expenses you’ll need to cover to maintain your lifestyle—and your life. Food. Gas. Electricity. Replacing the dishwasher. Car insurance. Taxes. Netflix.
So whatever your dream of retirement may entail, it isn’t free. And if your dream includes being able to step away from the 9 to 5 or the graveyard shift or just having to rely on a paycheck from a job in order to not find yourself put out of the life you’ve built, well, you’re going to need to start saving for it. Because no one is saving that money for you. And the earlier you start saving, the better. And if you put your savings in the right places and invest it wisely, you’ll witness the beauty of compounding. Time will be one of your greatest allies. And if you pay attention to your investments, you’ll learn how connected we all are. How we all play a part in driving the economy. You’ll be motivated to help it grow. Because as it grows, so do your investments.
How much to save.
Fine, maybe I’ve convinced you that you shouldn’t be spending your entire paycheck in the present. But you aren’t going to save everything. I mean, you can’t. Retirement may come at a cost, but so does the present day. Maybe you aren’t even making much money right now. It’s likely you aren’t if you’re in your 20s. That’s okay. Figure out how much you CAN save – yes, make a budget, see what’s left over after your necessary expenses—and start there. What’s feasible? (And don’t forget to sock some away in an emergency fund for car repairs or future rent. You don’t want to be in a situation where you tap into your retirement savings to pay off an unexpected expense. That’s bad.)
A rule of thumb for retirement savings is about 17% of your yearly before-tax salary. If you read 17% and can't imagine being able to put away that much right now, then, hey, relax. Breathe. Take a knee. Start with 10%. Still too hefty? 5%. Do what you can right now. We're not all at the same place in our careers. But contribute something today. You don't want to wake up in a decade and realize you haven't put away anything, do you Rip Van Winkle?
This will be the money that pays for your lifestyle (and life) when you decide to step out of the daily grind of the workforce. You may have heard of it as paying yourself. It’s a great way to look at it. You want to be your boss in retirement. You want to answer to no one except for the call of the wild and your sidekick Charlemagne the miniature schnauzer. Well, your boss—you—needs a pool of money in order to have an employee—you—to support. So when you’re analyzing your budget and how much you can afford to save every paycheck, think about what you’ll be putting that away for. Hint: it’s you.
So aim for a total of 17%. If you are fortunate enough to work for a company that has benefits like a matching program in a 401(k) or an IRA, take full advantage of that match. If the company says they’ll match 1% of your salary you contribute, AT LEAST put in that 1%. If they match 3%, put in 3%. 5%, put in 5%. 10%, put in 10%. If your company matches 3%, for example, then to make it to that 17% contribution target, all you have to contribute now is 14%.
And revisit this EVERY YEAR. It's unlikely that you can change the amount you contribute more frequently than that. Does the match where you work increase every year you work there? You’re going to want to check so that you can increase the amount you’re contributing. And maybe when you just start out, you can’t afford to contribute more than the match. Fine. Go back and examine your budget again. Can you contribute more this year? Did you get a raise? Don’t spend that raise; increase your contribution to your retirement account! You don't have to contribute all of your raise, but split it. Half you pocket now, half you put away for your future.
Prioritizing your retirement savings now, in the present, will be an incredible reward for your future self. Future self will be so pleased. So look out for your future self. Make your future self proud.
Where to put it.
All right. You’re on board. You’ve decided to commit to this and get on the retirement savings train. Excellent. Where do you put this money that you’ve decided not to spend on extra dinners and clothes and gadgets and books and coffees and pub nights and whatever you’re overspending on. You’re going to learn to cook and eat leftovers, get a library card, shop at thrift stores, realize you don’t need another new iPhone, host Mario Cart parties at your house, and maybe even take up running. Maybe just easy walking to podcasts. No pressure.
There are three types of accounts you can put your money in. Why three types? Taxes. Everything is taxes. See our Newsletter 87 for more info.
Tax-Deferred Accounts (Traditional IRAs, 401(k)s, 403(b)s, there are more…).
This is where you put your before-tax money. It goes right in. No taxes taken out. And it grows tax-free. You put it in, invest it, and you can buy and sell and pay absolutely nothing on the earnings until you withdraw the money. Once you’re old enough and begin to withdraw the money, the tax you pay depends on your income tax bracket. Now, of course, if you withdraw the money before you’ve reached a certain age—right now it’s 59 and a half—you have to pay a penalty in addition to those income taxes. So don’t do that if you can help it.
There are certain circumstances in which you can make withdrawals from these accounts without penalty: to pay for college or to make a down payment on your first home, for example.
Once you reach a certain age—right now it’s 70 and a half—you are required to start withdrawing a percentage of your retirement savings out of these accounts. Which means you have to pay income taxes on it. This brings us to the next type of account which doesn’t require you to pay income taxes on the withdrawals.
Tax Exempt Accounts (Roth IRAs).
If you want your money to grow in an account where you don’t have to pay taxes on the earnings until they’re withdrawn, but you want to go ahead and pay taxes on the money you put in NOW rather than later when you are retired and withdraw it, you put it in a Roth IRA. (Named after a guy named Roth). Why would you do this? The idea is that right now you’re earning less—you’re in a lower income tax bracket. So, it’ll cost you less in taxes right now than it will later when you retire. You put your after-tax money in a Roth IRA, invest it, it grows in that account without taxes on the gains, and you withdraw it later if you need it—no income tax.
This way, if you find you still need or want extra money out of your retirement savings, but you don’t want to pay more in income taxes by withdrawing more from your regular IRA account, you can just take it out of your Roth IRA. Amazing.
The third type of account is just a taxable account. It doesn’t get to go in tax-free. It doesn’t get to grow tax-free; you pay tax on the capital gains and dividends. But It does get to get withdrawn without tax consequences. But, hey, it’s money, and it’s your money just waiting in the wings. You pay taxes on the realized gains—realized just means that you’ve actually sold that investment so it can’t still go up or down with the stock market. You pay taxes on the dividends—some investments pay dividends, which is a portion of their earnings. But the amount you pay in taxes for these has a cap of 15% for those earning less than $400k. Even if you’re earning more than $400k a year, it’s still less in taxes than your income-tax bracket. So, this is another great place to save your money.
How to save.
There are limits on the amount you can save in retirement accounts (accounts with preferred tax treatments) each year. If you’re under 50, right now you can contribute up to $5,500 in an IRA or a Roth IRA. This is combined. So if you save $5,500 in a Traditional IRA, then it’s $0 in a Roth. There are also income limits for contributing to Roth IRAs. So if you’re making above a certain amount of income each year (and, yes, it’s a higher limit on income for marrieds), then you can’t put that money in a Roth IRA. Visit the ever exciting page of the IRS for details.
401(k)s have higher annual limits on the amount you can contribute: $18,000. Once again, visit this IRS webpage.
Don’t sabotage your savings.
It can be tempting to take money out of your retirement savings. Say you leave one job and start a new one. Instead of rolling that 401(k) balance over, you decide to withdraw it and go on a trip. Sounds fun until you realize you’re back to Go and have to start all over again on your savings. And you don’t take the money out without paying taxes on it. And you’ve erased the possibility that those funds can grow and wiped out the magic of compounding. So hands off. If you want to take a trip, budget for it. Budget for two. Budget for three. Whatever. You know yourself. What do you want to do? Great. Plan for it. Put it in your budget. You also probably know yourself well enough to know that you’re not going to want to work five days a week when you’re 72. So budget for that too.
Don’t make it harder than it already is. Give yourself a light at the end of the tunnel. Be your future self's own angel (investor).