One of the best financial moves you can make is to open a retirement plan and consistently contribute to it.
Getting an early start means decades of compound interest working in your favor as a result of your contributions, and, in many cases, your employer’s contributions. It also means putting less pressure on yourself and the amount you will need to contribute later in life to achieve similar results.
Develop a retirement plan with these tips.
Contribute enough to get your employer match
This is one of the most common pieces of financial advice out there. An employer match on a retirement plan – such as a 401(k) – is the amount of money your employer will also contribute to your account. Generally, however, the big catch is that they won’t do it unless you do it too.
For example, let’s say you earn $40,000 per year, and your employer will match your contributions up to four percent. That means you must put four percent of your paycheck toward your 401(k) ($1,600 total) and then your employer will do the same. As a result, you’ll end up with $3,200.
Unfortunately, sometimes employers include limitations that state you must work at the company for a certain period of time (often one year) before the company will match your contributions. Even if that is the case for you, it’s still beneficial for you to put money into your 401(k) in the interim rather than waiting until the match starts.
What if you can’t afford to get the match?
Let’s say your employer offers a five percent match on your 401(k). While five percent might not sound like a huge chunk, perhaps your other short-term financial goals require some attention – so you can’t afford to put in the full five percent.
In that case, a great strategy is to start contributing one percent (or more if you can swing it) so that your employer at least contributes that much to your account as well. Every little bit counts when it comes to compound interest. Then every six months, try to push it up by another one percent until you reach your five percent (or more) goal.
What percentage of my salary should I be putting into my 401(k)?
The rule of thumb is to put 10 to 15 percent of your salary into your retirement plan. But don’t be discouraged if that feels completely unattainable right now! Instead, start with taking advantage of the match, and then keep pushing up by that one percent every three to six months until you reach your goal.
As you increase your contribution amount, evaluate your overall budget as well as your short-term goals (such as building up an emergency fund and paying off student loans and/or credit card debt) instead of just fixating on retirement. Creating a sound and effective financial plan is all a balance.
Know your vesting schedule
A vesting schedule is a key concept to understand when you sign up for a company retirement plan. While your employer may offer a match, it doesn’t always mean you get to walk away with all of that money whenever you leave the company.
Vesting means “ownership” when it comes to your retirement plan. You must be 100 percent vested in order to own 100 percent of the money your employer contributed to your account. Otherwise, when you leave, you lose the percentage of the money that has not yet vested.
Often times, employers use a vesting schedule as an incentive to keep you at the company for a set period of time. There are three different vesting periods: immediate, graded and cliff.
- Immediate is simple. You can leave the company at any point and take the full employer match. Your contributions are 100 percent vested immediately when you start working.
- Graded means a percentage of the employer match vests each year. That’s the portion you get to take if you leave. A typical graded schedule is something like 20 percent in year one, 40 percent in year two, 60 percent in year three and so on until you’re 100 percent vested.
- Cliff is the most unfortunate kind because it prevents you from owning any of the money until it fully vests, often around year five. If you leave before year five, all of the employer’s contributions are returned, and you get to keep nothing.
Remember though, this only applies to the employer’s contribution. You always own the money you contribute.
How to start building a portfolio
The most overwhelming part of contributing to a retirement account is figuring out which type of investments you should pick. While that decision is unique to everyone’s personal situation, one of the quickest ways to start is with a target date fund.
Target date funds are a type of mutual fund that is tied to the approximate year you plan to retire. The investments are designed to be more aggressive when you’re young and slowly adjust to a moderate risk and, ultimately, a conservative risk as you approach retirement age.
Target date funds may sound like a magic bullet, but there are a few downsides. The fees are often more expensive, and they are a one-size fits all solution that isn’t tailored to you, which means it may not be the best possible fit for your situation. However, when you’re just getting started, it at least ensures your money is working for you in some capacity. You can always change your investment strategy in the future.
Source : TaxAct Blog