Crossing tasks off your daily to-do list is always rewarding,but we often forget to plan for long-term items, such as preparing for retirement. This may seem daunting, but fear not: You can do things today that will help define the life you'll live tomorrow.
Visualize the life you’ll want
What will your life in retirement 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. 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). It pays to understand your options and benefits now rather than later.
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. 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. As long as you meet certain requirements, 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 it 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.
But you should make sure the money is being invested the proper way. You don't need to come up with some complicated approach to figuring out where to put your money. 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.
Try to 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 tax penalty in addition to income tax.