A person with long, blonde hair sits on a rocky ledge, pondering how to save for retirement while gazing at a misty forest and distant hills during sunrise or sunset, the sun low on the horizon.
| | |

A Painless Guide On How To Save For Retirement

ByAllison

So you nailed the interview, started your first job — and now you're home after your first day filling out all the paperwork HR gave you. You remember a retirement account being mentioned when you accepted the job, but you have no clue what that means. This simple guide will walk you through the basic types of employer-sponsored retirement plans and provide a foundation for learning how to save for retirement.

This post may contain affiliate links. Check out my Disclaimer for more information!

The Basics of Retirement Accounts

The main purpose of a retirement account is to provide a place where money can be saved for use in retirement. The money is invested and any return that is made is added to the account.

There are two main types of retirement plans that are seen today. Defined contribution plans are more common and include 401(k) and IRA plans. Defined benefit plans are usually known as pensions and are now pretty rare.

Your employer may offer one or multiple types of these accounts. For example, my employer offers a 401(k) and a Roth 401(k) option.

Different employers have different rules about when you can start contributing to their plan. You may be eligible immediately, or you could have to wait a certain period of time. At my current job, I became eligible on the first of the month following my first 90 days on the job. My first job out of college required me to work for a year before I was able to contribute. My previous job let me contribute after 30 days.

Employer match contributions usually have vesting requirements. Becoming “vested” means you are entitled to those retirement funds if you leave the company. Usually, the account will have a scale for vesting. Say there's a 5-year vesting schedule. After your first year of employment you will be entitled to 20% of your pension benefits, after two years of employment it'll be 40%, and so on until you hit 100% vesting after 5 years of employment.

Retirement planning involves so many decisions, it can get overwhelming pretty quickly. Don't worry! After reading this guide, you'll understand the different types of retirement accounts. Understanding how your retirement account works will enable you to make better decisions to save for retirement.

401(k)

A 401(k) is an employer-sponsored retirement plan. It is a defined contribution plan, and the money is invested pre-tax (so before taxes are taken out). Some employers also offer matches on the contributions their employees make. The money is taxed when you withdraw it once you retire.

When you put money into a 401(k), the money is then invested in different funds. The money that is made from these investments is also added to your account and reinvested. Most 401(k) plans offer several different investment options for different risk levels. There is usually a range from conservative to aggressive funds. You get to pick the investments you want your money to be invested in.

401(k) plans do have restrictions on how much money you can put into the plan and when you're able to take money out. For 2019, the 401(k) contribution limit is $19,000 (unless you're over 50, then you can contribute a little more). Each individual plan has rules about when employees can start contributing, employer contribution vesting, and when money can be pulled out of the plan.

These types of plans became more popular as pensions started to fade. If your employer offers a 401(k), ask the plan administrator at work about these items:

  • when will you be eligible to contribute to the plan?
  • does your employer offer a match or profit-sharing contribution?
  • is there a vesting schedule for employer contributions?
  • what are the rules for taking money out of the plan at retirement?
  • what are the investment options?

Roth 401(k)

A Roth 401(k) is very similar to a regular 401(k), but the money that is contributed is after-tax dollars instead of pre-tax. This means when you withdraw the money once you retire, you won't have to pay tax on it at that time.

A Roth 401(k) functions just like a traditional one. It has the same contribution limits and can be invested in the same ways. The main benefit of using a Roth 401(k) vs. a traditional 401(k) is paying the tax upfront. If you think you will be in a higher tax bracket when you retire than you are now, you could save money by paying the taxes now at the lower rate.

A lot of employers will have a Roth 401(k) option along with a traditional 401(k) option. Often you can split your contribution between the two if you want. This can be a great way to take advantage of both types of plans.

403(b)

A 403(b) plan is sort of like a 401(k) for employees of a tax-exempt organization, though they operate a little differently. These plans are available to the employees of schools, churches, and other tax-exempt organizations.

Employees make pre-tax contributions to the plan from their salary. Employers can also match employee contributions to the plan. The money is either invested in mutual funds or annuities. The investments are done through an insurance company or mutual fund custodial account. These accounts also usually vest much quicker than a 401(k).

The contribution limits for 403(b) plans are $19,000 for 2019 (unless you're 50 and older). The easiest way to check for the current year guidelines is to go to irs.gov.

Here are some questions to ask about your 403(b):

  • when are you eligible to start contributing to the plan?
  • what are your investment options?
  • does the employer match employee contributions?
  • what is the vesting schedule for match contributions?

Pensions

Pensions are not a common option for employers to offer anymore. These are defined benefit plans. The employer sets guidelines for determining how much an employee will receive once they retire and are responsible for paying that money out.

A pension is funded by the employer – they put money into investments and use the income from those investments to pay out the required amounts to their employees. There is also usually a scale for vesting with a pension and employees are generally enrolled within their first year of employment.

It is pretty unlikely that your employer still has a pension unless you work for a government entity. If you do have a pension option, here are some things to ask about:

  • when will you be enrolled in the plan?
  • what is the formula for determining retirement benefits for each employee?
  • what are the vesting requirements?

Do I Keep My Money if I Change Jobs?

If you change jobs you are able to take the money in your retirement account with you. Your contributions and your employer's contributions to the plan will stop, but the money that is in the plan will stay in the same investments. You can continue to make money off the investments even though you aren't actively contributing to the plan.

This is when vesting is important. You will only be able to keep the portion of the employer contribution that you are vested for. If your vesting schedule is 5 years and you've only been at the company for 2 years before you leave, you'll only be 40% vested. That means you'll only get to keep 40% of the contributions your employer made.

When you get to your new job, I would ask about the eligibility requirements for the new plan and what options are available to move your money from your old plan to your new plan. What you DON'T want to do is take any type of lump distribution from the plan — you want to do a Rollover. You will get charged a whole ton of taxes on the money if you take a distribution before 59 1/2 years of age.

Some plans will charge a fee to your account if you are not actively investing in the plan any longer. In this case, I would want to move my money if possible. It generally is much easier to keep track of your retirement investments if they're all in one place. However, in some instances, you may not be able to roll your money into your new employer's account. You won't be able to Rollover a Roth account into a traditional 401(k), for example.

Tips on How To Save For Retirement

There are several other retirement account options out there, but I covered some of the most commonly seen employer-sponsored plans today. Regardless of what type of plan you have, starting to save for retirement early is really important. A good start is to take interest in your retirement now and start learning what investments will be a good fit for your situation.

Something I hear from people all the time is they want to start with a small contribution now and increase it later on. I would NOT recommend going this route.

The more you contribute from the start, the easier it will be to keep that contribution going. It will be much harder to give up the money you're used to having in your pocket when you increase your percentage later on. Starting early is the best way to maximize your retirement savings, so the more you contribute from the start, the more money you'll be able to save!

Want to learn more about managing your finances?

Share

Similar Posts

One Comment

Comments are closed.