Financial Security Step 2b: Begin Saving for Retirement

The beauty of saving early for retirement is in compound interest. Your small contributions grow over the years to fund life after work.

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If you’re new to the Financial Security Steps, start here: Welcome!

One of the most important things you can do, now, today, is to start saving for retirement, if you’re not already. Ideally you’d save a lot early on in your career, so your investments have time to grow before you retire. I realize not everyone can put away half their paycheck, but it is still important to begin saving right away, no matter your age.

Even if you’re already saving for retirement, you need to consider how much and how you are saving.

Save early

I used a calculator on bankrate.com to run these scenarios

If you start saving for retirement at 25:

• Salary of $40,000, increasing at 2% per year
• Contribute 10% of salary, beginning at age 25
• Retire at age 64
• Annual rate of return of 7%
• No employer match
• Your retirement account balance will be $1,059,639 by age 65

If you start saving for retirement at 45:

• Salary of $40,000, increasing at 2% per year
• Contribute 10% of salary, beginning at age 45
• Retire at age 64
• Annual rate of return of 7%
• No employer match
• Your retirement account balance will be $197,855 by age 65

If you start saving for retirement at 45:

• Salary of $40,000, increasing at 2% per year
• Contribute 50% of salary, beginning at age 45
• Retire at age 64
• Annual rate of return of 7%
• No employer match
• Your retirement account balance will be $909,381 by age 65

Those numbers are shocking. Thanks to compounding interest, saving a mere 10% of your salary from ages 25-65 makes you a millionaire. Saving (a probably unreasonable) 50% of your salary from ages 45-65 makes you a 9/10ths millionaire.

If you’re closer to 45 than 25, do not get discouraged yet. Today is the day to turn your finances around. It’s not too late, but you need to begin saving today.

How do the Financial Security Steps address retirement?

Dave Ramsey recommends putting retirement contributions on hold until you have saved a mini emergency fund, paid off debt, AND saved 3-6 months of expenses for a full emergency fund. Depending on your debt and income, that is probably going to take years. I think it’s foolish to throw away those years of compounding interest and (hopefully) employer contributions.

For my family, I ran the numbers. Stopping retirement contributions would get us out of debt about 6 weeks faster. That’s it. We chose to keep contributing over 10%, even through debt payoff. We are planning on supporting our oldest daughter throughout adulthood, so the extra funds are necessary.

If you are still in debt, my retirement savings recommendation has two options:

• If your employer matches a portion of your contribution, invest at least that much. This allows you to receive the employer match, which is free money.
• If your employer does not match any contributions, invest at least 3% of your income. It’s a small enough portion that it won’t set your debt payoff back by much, but it adds up in your investment account.

Once you are out of debt and have saved six months’ expenses in a full emergency fund, work up to contributing 15-20% of your income.

What type of investment is best for saving for retirement?

The safest growth investment option is a index fund, which is basically purchasing a portion of all the stocks or bonds that are part of the index, or group, tracked. This averages out the gains and losses of the individual stocks so your investment is safer overall. The average long-term rate of return (how much the value increases) of the S&P 500 index fund is about 10% per Investopedia. That is over nearly 100 years, so it’s important to remember to stay calm during market fluctuations.

Another important consideration is whether to invest in individual stocks or your employer’s stock… and I say go ahead. But, limit your investment in any single stock (aka, anything that is not an index fund), especially your employer’s, to less than 10% of your portfolio. This comes down to a combination of don’t put all your eggs in one basket and remember Enron. Among many other errors and crimes, the company Enron contributed company stock to their employees’ 401(k) plans. Many employees also chose to invest in company stock with their own 401(k) contributions. When Enron imploded due to fraud, the company stock tanked, employees couldn’t make changes to their 401(k) allocations, and many lost their retirement savings.

If you’re a more savvy investor, you can definitely play around with allocating your contributions and try to outperform index funds. If you’re following a series on how to get to financial security, to save and pay off debt, you’re not in that place yet. Start small and start safe.

Use your employer’s plan for saving for retirement

Many employers offer retirement plans for their employees. Even better, many will match your contributions up to a certain percentage or amount. For example, if you contribute at least 3% of your income to your retirement account, your employer will contribute the same amount. If you contribute 5%, they will still only contribute 3%.

Retirement account types and limits

Retirement accounts usually offer tax advantages over regular savings or investment accounts. You can learn more at SoFi or from the IRS, but below is a brief overview.

Account	For	Contribution Limit – 2021	Taxed At
401(k)	Employees	$19,500	Withdrawal
IRA	Individuals	$6,000	Withdrawal
Roth IRA	Individuals	$6,000	Contribution
Roth 401(k)	Employees	$19,500	Contribution
SIMPLE IRA	Employees	$13,500	Withdrawal
SEP	Self-Employed	$58,000	Withdrawal
457(b)	Government Employees	$19,500	Depends on plan
403(b)	School Employees	$19,500	Withdrawal

If you’re older, these plans all allow for catch-up contributions. Many also have restrictions on income. For example, if a single filer has a Modified Adjusted Gross Income of $137,000 or higher, they are not eligible to contribute to a Roth IRA.

You’re probably only eligible for a few types of accounts, depending on your employment situation. Individuals must have earned income to contribute to either an IRA or Roth IRA (and the contributions are limited to the lesser of $6000 or the earned income).

Tax considerations

I recommend investing in a Roth account, especially if you’re on the younger end of the spectrum. A Roth account taxes your contributions when they’re made, so the withdrawals in retirement are tax-free. Contributions to a pre-tax account like a 401(k) will reduced your taxes now, when the contribution is made, but you’ll have to pay taxes when you withdraw the money later. The assumption is that the tax rate in your 20s is lower than it will be in your 70s. Of course the tax laws can, and likely will, change by then, but it’s hard to see drastic tax cuts considering the level of national debt.

Roth accounts also allow you to withdraw, tax-free, your contributions. Any returns (increases due to the stock market going up) cannot be taken out until retirement, but the amount you actually contribute can be. I don’t recommend that unless it’s dire, but it’s an option. You can also use the funds for certain home purchases, higher education or adoption fees.

Traditional accounts are of course a great option as well. Even better, use multiple account types. Contribute the first portion to your 401(k) to get your employer match, contribute the next $6000 to a Roth IRA, then go back to your 401(k)… one day down the road when you’re financially secure.

To Start Saving for Retirement:

1. Ask: Does your employer offer a retirement plan? What type?
2. Ask: Does your employer contribute to your plan? How much? This is the minimum you should contribute right now
3. If your employer does not offer a plan or you’re self-employed, start an IRA, Roth IRA or SEP account. Contribute at least 3% now.

Step 9 of the Financial Security Steps is to increase your retirement contributions, so don’t worry about starting small. You’ll get there!

What is your next step?