About Y0ur Retirement Account
Welcome students to the next lesson. In this lesson, we are covering the importance of saving for retirement and by the end of this lesson, you will be contributing to your own retirement investment account. This will be another easy lesson in this course and it’s also the most important. First, we talk about why you contribute to a retirement account, and last you'll learn how to contribute to your retirement account.
Let's start with why. You have to contribute to a retirement account today because one day you want to retire. You are retired when work is optional because you don’t work for money to survive. When this day comes you will live off of the income that you saved/invested. For most people, this is around 65 but it doesn’t have to be. It can be any age as long as you have the money to survive. In the last lesson of this course, we will focus on retiring sooner.
It may seem difficult to save that huge amount of money it may even seem impossible but only because we were never taught this stuff. I’ll give you a hint, in order to save hundreds of thousands of dollars in about 20 years, we're going to let someone else contribute the majority of that money. The main thing is we have to get it started.
if you fail to start your retirement account, or if you have one but don't contribute to it, then when it’s time for you to retire you will be counting on others to take care of you. Most of the time this comes in the form of putting the financial burden on your children, and if you're lucky you may be able to collect Social Security. But that's only if it's still available at that future time. We have no idea of the law changes that will happen in the coming decades. Plus, living on Social Security alone will still mean you are below the poverty line. Today the average Social Security benefit is less than $1,400 a month. I don’t know how much your rent is but I wouldn’t be able to afford much of anything else. Wouldn't you rather continue your current lifestyle or have even more money when you retire?
The best case scenario is you start today by putting any consistent amount into your retirement savings every pay period, continue doing this without touching it until retirement, make sure it’s being invested and 30 years later you have half a million dollars in that account. Seems like a pipe dream but that’s literally the most attainable route to hundreds of thousands of dollars in wealth!
Start Contributing - Option 1
If you work for a corporation your employer most likely offers some type of retirement account; for the majority of us, this is called a 401k. For others your employer may provide another called 403b and there are others, but one of these two are offered to about 95% of employees. If you are self-employed you don't have an employer so there is nobody to offer this and you must (absolutely must) take care of this for yourself. The most common tool for the self employed is a self-directed IRA.
So, there are only two options: either you use the retirement account offered from your employer, or you open your own retirement account. And actually, because I like you so much, I’ll give a bonus option. The third option is you can do both!
How-to for Option 1: Your employer provides access to a retirement account; we will use 401k as an example. In most cases, you are automatically enrolled and this account is already set up for you. In this situation, all you have to do is find out how to make regular contributions every pay period! If you are not already enrolled, you will have to figure out how to for your job. Most corporations have an employee dashboard you can log into and find a section for your finances. If you are not able to do or can't figure out how, there is a simple solution which is to contact Human Resources. It is their job to assist you with these types of concerns.
Once you know where you can manage your contributions, you will need to choose a percentage of your paycheck that will go towards retirement. In the book, The Richest Man in Babylon, one of his laws is to save 10% of everything you earn. I believe this is possible for everyone, but it doesn’t have to be where you start. 10% is a great rule of thumb and should definitely be your goal. I say, the minimum contribution is the percentage required to get the maximum matched contribution from your employer. Not every employer will offer a match, but many do. This match is literally money they add to your net worth every pay period because you show that retirement is important to you. If you don’t take advantage of this, you are literally wasting FREE money. You can contribute more than the full employer match percentage, that’s just my recommendation for the minimum. I still think 10% should be everyone’s goal. Now, if your employer does not match, you're not off the hook, you still need to contribute!
Let’s look at an example of an employer that matches your contribution 100% for up to 5%. That means when you contribute 5% of your paycheck for your retirement investment account, for every dollar you put they will also pay a dollar too. If you make $60k/year that means every pay period you put in $115.39 AND your employer adds $115.39 to your net worth. That’s EVERY pay period! After 3 years that’s just under $10k added to your net worth that someone else contributed for you and that's without the growth from it being invested. THAT’S HUGE!
Now that your account is opened and you have contributions automatically going to it now there is one step left.The most important thing that is: you need to make sure that you are able to invest your contributions. I won’t tell you what you should invest in, but I will tell you what I do with my contributions and why. I buy shares of index funds because the fees are practically $0 and I plan to keep them for decades. Research this investment strategy (index fund investing) and make a decision on what you want to invest in, but don’t let your money just sit and lose value. If you want advice for where to invest or how please contact your personal financial advisor.
Start Contributing - Option 2
How-to for Option 2: This option is for the people that are either self-employed or their employer does not offer a retirement account. You are going to open a self-directed IRA today! This is something you can get done in less than 15 minutes after this lesson. There are two options for self-directed IRAs: you can either open a traditional IRA or a Roth IRA. Both options are retirement investment accounts, both options are good, both work, and both options will get you to your retirement goal. There are a few differences but the big difference to distinguish between the two is taxes.
With the traditional IRA, you contribute using pre-tax dollars, similar to a 401k. This means when you get paid, money will automatically go to your retirement savings before it is taxed. With the Roth IRA, you contribute with post-tax dollars meaning when you get paid taxes and other expenses come out then your check is deposited. Afterwards, you automatically transfer your desired contribution amount.
The benefit of the traditional IRA is it's said to grow faster simply because you the full amount (including taxable amount) is growing in this account. The Roth IRA is said to grow slower because the taxes aren’t growing with the account. This is like putting $100 in two accounts. One gets taxed 10% and the other doesn’t so now one grows with the $100 in it and the other with only $90. This is just an example but it shows the difference between pre-tax and post-tax contributions. In the example you could just put $110 in the taxed account to even the playing field.
The benefit of the Roth IRA matters decades later when it’s time to retire. When you are able to start withdrawing money from your Roth IRA you don’t have to pay taxes because you already did before contributing. With a traditional IRA you would pay taxes on withdrawals the same as you do now when you get paid, because it's considered income and you didn’t pay taxes on it yet. So the example here is let’s say two people have IRAs one Traditional and one Roth. After retirement they pay themselves $5,000 every month. The person with the traditional IRA would pay a tax of let’s just say 10% and end up with $4,500 and the person with the Roth IRA would get the full $5,000 because they already paid taxes on their money.
I'm not here to tell you which account is better and I personally think the outcome will be about the same. You should speak with your personal financial advisor if you have more questions. But what I am here to tell you is regardless of which IRA you choose, you need to start today! The only person that loses is the person that doesn’t start.
To start this account today, search online for self-directed IRA accounts. There are many options, but here are a couple that I like: Charles Schwab (I use this one), TD Ameritrade, Fidelity. You should research and see value in a company (not only from my list). Choose one and open an account. Once it’s opened you need to log into your account and find transfers. Here is where you can connect your bank account and set up automatics transfers to happen every payday. Then pick an amount and complete the transfer. Just a hint for the amount, you can only contribute up to $6,000/year to any IRA (as of 2020). I set my deposits up for $250 twice a month which gets me exactly to that max. You don’t have to do this amount but it’s a good round number to set as a goal.
Now that your account is opened and you have contributions automatically going to it now there is one step left. The most important thing is: you need to make sure that you are able to invest your contributions. I won’t tell you what you should invest in, but I will tell you what I do with my contributions and why. I buy shares of index funds because the fees are practically $0 and I plan to keep them for decades. Research this investment strategy (index fund investing) and make a decision on what you want to invest in, but don’t let your money just sit and lose value. If you want advice on where to invest or how please contact your personal financial advisor.