Pay mortgage bill on time. Check!
Enroll in benefits at work. Check!
Saving enough for retirement goals. Maybe?
Crossing tasks off your daily to-do list is always rewarding. But we often forget to plan for longer-term items such as preparing our older (and hopefully wiser) future self for retirement. The good news: You can do things today that will help define the life you'll live tomorrow.
Visualize the life you’ll want
What will your retirement selfie look like? Will you be at a golf course? Taking care of grandchildren? Volunteering at a local animal shelter? The first step to understanding how much you need to save is visualizing what location and lifestyle you want. (Take your time, we'll wait.) Then work through what it'll cost to live that way and how much you think you'll need to save to get there. That's what your plan is meant to accomplish.
Get your employer plan ready for its close-up
Fortunately for you, most employers provide a retirement savings plan—usually a 401(k)1. It pays to understand your options and benefits now rather than later.
First of all, the money you contribute to your employer-sponsored plan is taken out automatically, so the money never hits your checking account.
In a traditional plan, your contributions are pre-tax. You effectively reduce your taxable income amount, because taxes will be based on your income after the contribution is taken out. And an added tax benefit: Your account grows tax-deferred, meaning that you don't pay federal income tax on it until you take withdrawals at retirement.
Your plan may offer a Roth feature, which allows you to contribute money after-tax. In this case, you will pay tax on the full amount of your paycheck and then contribute to your Roth account, so you won't be reducing your current taxable income. But you won't pay any tax on your withdrawals when you retire.
How to choose the right plan for you
Contributing money pre-tax is a good choice if you think your income will be lower when you retire. You will pay less tax on the money during retirement than you would if were taxed now. This could be attractive if you are a high earner. You probably could use a tax break.
Choose Roth contributions when you think you will have higher earnings after retirement. Also, if your current earnings are low, you may decide that the tax savings from pre-tax contributions are not significant. You can set aside dollars that will not be taxed during your retirement years. You'll enjoy tax-free living.
No matter which plan you choose, once your money is invested, it will work in your favor. With compounding, thanks to interest and investment growth, it can grow on its own. Your employer may even match your contributions up to a certain percentage (Winning!).
But...your future self would tell you to make sure the money is being invested the proper way. You don't need to come up with some kind of complicated approach to figuring out where to put your money. Take a look at your plan, and you will notice a diverse set of investment options to choose from. Select investments you feel are right for you based on your age, risk tolerance and objectives, not just the recommendations of friends or co-workers. Your plan will usually ask you preferences and can help guide you in the right direction.
Note from future self: Please keep those contributions going! But, if you need to take withdrawals from the plan before you are age 59 ½, you may be subject to a 10% tax penalty in addition to income tax.
Ways to save outside of work
The plan to reach your retirement reality doesn't have to be restricted to what you do with your employer. Here are three more savings options to explore:
- Open your own Traditional IRA2. Remember, these individual retirement accounts (that's what IRA stands for, in case you were wondering) let you contribute pre-tax dollars, reducing your taxable income. You can invest the money in stocks, mutual funds, bonds or other vehicles and then withdraw the money without penalty starting at age 59½. The withdrawals get taxed as ordinary income.
- Consider your own Roth IRA2. You can only contribute after-tax dollars, but the upside is that your earnings on the account and your withdrawals are tax-free. Score!
- Buy life insurance. Yes, life insurance is a way to protect your family in case something unexpected happens to you or your spouse/partner. But certain policies can help with retirement savings as well. With a permanent life insurance policy that offers the potential to build cash value, you may be able to access the cash value to help supplement income from other sources.
Your health is your wealth
Thinking about money can be overwhelming. Studies show that the stress of financial planning can be one of the biggest drags on how people feel, so don't forget to take care of yourself by eating right, staying active and taking time to de-stress. It'll make life better now, but it will also help you enjoy those days in retirement and minimize your medical expenses.
Nobody pictures a retirement full of health issues. But the fact is, a 55-year-old couple planning to retire in 10 years will need $182,447 to pay for basic Medicare coverage, according to HealthView Services, which creates software to project health care costs. And the sting of that will only get worse, as health costs are expected to rise more than 6% this yearopens in a new window.
If you make sure your to-do list today includes "go for a run," you might have less to worry about down the road.
Remember, there's no one-size-fits-all secret to retirement, so go easy on yourself and pat yourself on the back once in a while for being proactive. No matter what your future selfie looks like. Please consult your tax and legal advisors for advice concerning your particular circumstances.
1.The limit on employee contributions for traditional 401(k) plans is $18,500 in 2018 ($24,500 if you are age 50 or older and your plan permits catch-up contributions.
2. In general for 2018, your total contributions to all of your traditional or Roth IRAs cannot be more than $5,500 ($6,500 if you’re age 50 or older), or your taxable compensation for the year, if your compensation was less than this dollar limit. If you,or your spouse, if married, are participants in an employer plan your deduction for a traditional IRA contribution may be limited based on your filing status and income. Your Roth IRA contribution might be limited based on your filing status and income.
This article was originally published on 5/26/2017, and updated on 11/17/20017 to reflect updates to the IRS tax code.