Are you on track to retire when you want to? If not, you may not be saving in the right place. Where you save for retirement is just as important as how much you save. According to a recent survey by Morning Consult, about half of all retirement savers are saving in the wrong place. In the following, we’ll discuss the best options for everyone who wants to retire while they can still enjoy it!
Where NOT to Save!
While a savings account may seem like a safe place to hold your money, it’s not the best option for retirement. Unlike a typical checking account, you can’t simply break out your debit card or checkbook and spend that money. Further, you probably earn some interest on the money you have saved there. But guess what? It’s simply not enough. At most, you can hope to earn 1-2% on interest each year. However, that might not even keep up with inflation. As you may know, inflation effects the value of your dollar. One dollar today may only be worth 98 cents when you retire. If you correlate that with your earnings from a savings account, you may actually be losing money.
We’re not saying a savings account is all bad. Afterall, you should have an emergency fund that you can access easily if needed. However, once you have three to six months of your salary saved, there’s no reason to fund the account any more. That should be enough if a situation arises and you need money fast. There are much better options for long-term savings goal, especially retirement.
Where SHOULD You Save?
There are a multitude of tax-advantaged retirement accounts at your disposal. These can range from workplace 401(k) and SEP IRA plans to Individual Retirement Accounts (IRA) to self-directed plans. While all plans may not be available to you, there’s at least one or two you can start funding immediately. And, the sooner you start saving in one, the better off you will be.
Here’s a brief description of the key retirement plans (follow the links for detailed info):
The most prevalent workplace retirement plan is the 401(k). They’re great for many reasons. First, contributions are automatic. They are taken from your salary, before you get a paycheck. Many employers offer a matching contribution. This is the easiest way to “free money” for retirement. Lastly, since all contributions are taken before you get paid, you don’t pay taxes until you withdraw the funds during retirement. You are limited to the annual contribution limit of $19,000 or $25,000 if age 50+ for 2019.
Anyone can open an IRA, so they’re the most utilized retirement plan. As long as you have earned income on the year, you can contribute up to the maximum amount, For 2019, that’s $6,000 (plus an additional $1,000 if you are at least age 50). Like traditional 401(k) plans, they are funded with pre-tax dollars. Therefore, taxes are deferred until retirement, just like the 401(k).
SEP & SIMPLE IRAs
SEPs and SIMPLE IRAs are found at many small businesses since they’re cost effective. SEPs have high contribution limits ($56,000 for 2019) while SIMPLE IRAs have a $13,000 with a $3,000 catch-up. They are very popular plans for those looking to start their own business because of their ease of use.
Roth options are available with many plans, but mostly for regular 401(k)s and IRAs. The major difference is when you are taxed. While traditional plans have deferred taxes, Roths are funded with after-tax money. However, all distributions during retirement are tax-free.
A Solo 401(k) is basically a traditional 401(k) that’s perfect for the self-employed. It has all the same features, including tax-free loans, Roth options and tax advantages. In addition, it offers much higher contribution limits than a standard 401(k). For 2019, you may contribute up to $56,000, plus an additional $6,000 if age 50 or older.
Self-Directed Retirement Plans
Last but not least, we wanted to mention self-directed retirement plans. While many plans can be self-directed, Self-Directed IRAs and Solo 401(k) plans are the most popular. By self-directing your plan, you can invest in just about anything you can think of, so long as it’s not prohibited by the IRS. Further, by utilizing checkbook control, you have the freedom to make any investment whenever you see fit.
Choosing Your Investments
Now that you knew where to invest, the questions becomes what to invest in. There are basally two ways to go about it: traditional assets or alternative investments.
Traditional assets include stocks, bonds and mutual funds. Your workplace 401(k) and IRAs you open at a local bank will only allow you to invest in these. Investing in bonds is akin to using a savings account. They won’t yield high returns, but they’re typically a safe investment. Stocks, on the other hand, are riskier, but have better returns. Historically, they yield about 7-8%, which is a far better return than you’ll see in your savings account. To limit your risk, you can also choose mutual funds, which consist of dozens of different stocks. Therefore, if one or two take a dive, you’re protected with the other assets in the fund.
The expert opinion in regards to investing in traditional assets is that you should take more risks while you are younger. As you get older, you want safer choices. This is because the younger you are, the more time you have to make up for a down year in the markets. The formula is to subtract your age from 100, and that’s the percentage you should invest in stocks. For example, a 25 year old should have 75% in stocks and $25 in bonds. If you’re 50 years old, you should have a 50/50 mix. Of course, everyone is different and may want to take on more or less risk.
Alternative asset investments
Alternative investments include everything else not prohibited by the IRS. The most popular investments right now are real estate, precious metals and business financing. While many financial institutions offer alternative investments, most require their consent before you can invest. A special custodian, such as IRA Financial, is needed if you wish to have total control of your retirement funds.
The IRS only specifies what you cannot invest in, which is basically life insurance, collectibles and investments involving a disqualified person. As long as the investment is federally legal, it can generally be made with retirement funds. The types of returns you can see on alternatives vary greatly. For example, a real estate deal might net you $100,000 or you could be lucky to break even. It’s up to you to figure out what to invest in, while staying within your risk tolerance.
Where you save for retirement is just the first step. It’s best to speak with a financial advisor to come up with a plan that caters to you specifically. Here are a few tips to get your started:
- If your company offers a retirement plan with a match, try to contribute enough to receive the full match.
- If you are just entering the workforce and/or haven’t reached your full earning potential, look at the advantages of the Roth plans.
- No matter what plan you choose, start funding one as soon as possible!
- Every bit helps…most people can’t afford to max out their retirement plans each year. It’s important to contribute as much as you can.
- Educate yourself. Find out as much as you can about a plan you are considering, including fees, investment options and availability.
Get in Touch
The retirement experts at IRA Financial are happy to help answer any questions you have about any of these retirement plans. Give us a call at 1-800-472-0646 or fill out a contact form and we’ll be in touch with you! Thanks for reading, and remember to start saving now!