From the time we first start drawing a paycheck, we hear it over and over again: put some of your earnings away for retirement! Whether the advice comes from our employer, our friends, our parents, our big sister, it’s like a mantra. And for many people, saving money comes easily and naturally. However, for many others, saving is a chore. How can we do it?
Automatic saving plans
The easiest way is to put your savings plan on autopilot: initiate direct transfers and you won’t have to think about it again. Increasingly, employers are offering their employees “defined contribution” retirement plans, the best known of which is the 401(k).
According to such plans, a certain amount of money is automatically deducted from your paycheck every pay period and deposited into your 401(k), which then compounds in value throughout your period of employment. All contributions are pre-tax, meaning that the amount of your contributions is deducted from your gross income before your tax bill is computed.
As an additional benefit, many employers offer matching contributions, but sometimes there is a minimum employee contribution before matching contributions kick in. When setting up your plan, be sure to take full advantage of any matching contributions and ramp up your own contribution levels to qualify for matching contributions if necessary. This is free money: don’t miss out!
Because of this tax benefit, annual contributions to a 401(k) are limited to $17,000 (in 2012); employees over the age of 50 can make additional “catch-up” contributions of $5,500 annually.
Even given the many benefits of a 401(k) plan, studies have shown that many employees — particularly those prone to procrastination — never seem to have time to visit their personnel office and set up automatic contributions. For this reason, many employers have established automatic enrollment 401(k)s. All new employees are automatically enrolled at a certain level of contribution, with contributions being invested in a designated default fund. It’s then up to the employee to stop the contributions, if he or she chooses to do so, or reallocate the contributions to a different fund. An automatic enrollment 401(k) is truly “saving for dummies”!
Your employer many not offer a 401(k), or perhaps offers a traditional retirement pension, which you’ll most likely have to supplement with additional savings. Another tax-advantaged retirement savings vehicle that you can take advantage of is the Individual Retirement Account (IRA), which you do need to set up on your own with an investment house. With a regular IRA, your annual contributions (limited to $5,000, or $6,000 for those over 50) are tax deductible, but your eventual withdrawals will be taxed as regular income. Roth IRAs work the opposite way: annual contributions (with the same limits) are NOT tax deductible, but eventual withdrawals can be made entirely tax-free. For most savers, a Roth IRA is more advantageous.
There is no “automatic enrollment” in an IRA, but once you’ve set up your IRA account, you can arrange automatic transfers from your bank account. Once this is established, you won’t have to think about it again — just be sure you don’t contribute over the annual limit, or you may owe penalties. If you have any questions, consult with a retirement specialist at the investment house where you’ve opened your account, or with a certified financial adviser.
Finally, if you’ve reached the contribution limits for your 401(k) and IRA accounts and still have excess income you’d like to save, open a regular (taxable) savings or investment account at a bank or investment house. Cash savings and money market accounts are paying horrendously low interest these days (as of early 2012), so consider various mutual fund options — stocks, bonds, or a mix. Do your research, be sure to diversify your savings, and, again, set up your regular savings plan with automatic transfers from your checking account.
If you’re still having a hard time getting started but your spouse or partner is more proactive about money matters, then discuss the issue with your partner and have him or her manage your savings plan for you, in a manner that you mutually agree upon. At risk of drawing stereotypes, in Asian families (Korea and Japan, for instance), women tend to be better at managing money than men. So the household breadwinner — in most cases the husband — hands his paycheck over to his wife every pay period for her to manage, and she then rewards her husband with an allowance — enough for lunch money and the occasional drink after work with colleagues, but not much else. It’s no wonder that household savings rates in Asia far outstrip those of Western countries! Depending on your family dynamic, you might take good advantage of such a strategy.
The best way to save for retirement is to get started now, regardless of your age. The longer you save, the more chance your savings will have to compound over time, and the more you’ll have in retirement. It’s that simple.