1. Have a plan – When you are saving for retirement you need to have a plan, whether that plan is developed on your own or with a financial planner.
It’s easy to read (hey – you’re reading this, right?) or hear about what to do to save for retirement, however, in the end you need a personalized plan that tells you how things will look, for you, financially, in retirement.
Once you’ve decided to save for retirement and you know where the money is going to come from, you have to decide where you are going to save the money.
2. Get company match/use Roth IRA – If you have a 401(k)* plan where you are employed you should contribute enough to get the company match – that’s free money you should make sure you are getting. Once you’ve contributed enough to get the company match, you should start or add to a Roth IRA the amount you are able to, up to the maximum allowed each year. For the tax year 2016, the maximum is $5500 if you are less than 50 years of age and $6500 if you are 50 or older. (You must have earnings equal to or greater than your Roth IRA contribution.)
If you still have money you’d like to set aside for retirement, after making the maximum Roth IRA contribution, you should increase the percentage of your salary that is being contributed to your 401(k). The maximum you can add to a 401(k) per year is $18,000 if you are less than 50 years of age and $24,000 if you are 50 or older.
If you have a Roth 401(k) available where you are employed, select this option. There are a few advantages to Roth IRAs and Roth 401(k)s. One of the most important is that although you give up the tax-deduction for your contribution, your earnings are never taxed.
If your company doesn’t provide matching funds to what you contribute to a 401(k), start with the Roth IRA and then use the 401(k). Even if there isn’t a company match there are still advantages to using a 401(k) for your retirement savings.
If your company doesn’t provide a 401(k), I would start with a Roth IRA and then use a taxable account. Self-employed individuals can save even more for retirement in a SEP IRA or a SIMPLE IRA. Taxable accounts and plans for the self-employed are discussions for another time and won’t be covered here.
3. Take advantage of compounding – However you save, the earlier you start the better, so that you can harness the power of compounding. If you start saving at age 25, and earn 6% per year on your savings, every dollar you invest will become approximately $5.75 by the age of 55 (almost 6 times what you invested) and will become approximately $10.25 by the age of 65 (more than 10 times what you invested).
4. Don’t be afraid of the stock market – In most cases you won’t be able to save enough for retirement unless you put your long-term savings at risk. The most conservative way to do this is with low-cost, broad-based index funds. You don’t want to try to beat the market, you want to own the entire market.
* NOTE: 403(b) plans are similar to 401(k)s and are typically provided by non-profit entities.