Build Your Own Retirement Plan

You may be wondering at what age you should start saving for retirement. That’s a simple answer – as soon as possible. The moment you start earning money you should think about saving for retirement. The earlier you start, the less money you’ll need to contribute, thanks to power of compounding. Compounding allows you to earn more money on the money you invest as long as you reinvest your earnings on that money.

So how do you get started? The first habit you need to incorporate in your weekly budget is to pay yourself first. Then be sure you take advantage of the free money from your employer if your company offers a qualified retirement plan. If you’re self-employed, you have different options to make saving for retirement easier. If you’re employed with no employee retirement savings options, then you can use a traditional IRA, but may want to consider a Roth. If you change jobs, be sure to take control of your savings by rolling them into an IRA. Finally, start developing a vision of where you want to go and how you want to live in the future.

Let’s take a closer look at these possible steps:

1. Pay Yourself First

Many people think of retirement savings as the money they put away if there is any cash left at the end of the month. Generally when you try to save that way, you tend to put away very little or nothing each month.

“Paying yourself first means saving before you do anything else,” says David Blaylock, CFP, senior financial planner at LearnVest Planning Services. “Try and set aside a certain portion of your income the day you get paid before you spend any discretionary money. Most people wait and only save what’s left over—that’s paying yourself last.”

Try putting aside just $10 a week (maybe bring two lunches rather than eat out twice a week or skip a few trips to your favorite coffee place). That may not sound like much but, thanks to monthly compounding, it could grow surprisingly large.

Let's say you save $40 per month and invest that money at 4.65%, which is what the Vanguard Total Bond Market Index Fund earned over 10 years. Using an online savings calculator, an initial amount of $40, plus $40 per month for 30 years adds up to $31,550. Jack up the interest rate to 8.79%, the average yield of the Vanguard Total Stock Market Index Fund over 10 years, and the number rises to more than $70,000. 

These sorts of funds aren't open to very small investors, however. If you’re starting with just $40 a month, you won’t be able to purchase these higher earning investments right away. You will need to start with an IRA at your local bank. Most banks allow you to start an IRA using a money market fund for as little as $100. You will need to build that fund to savings level of $1,000 in order to buy into an IRA at most mutual fund companies. At $40 per month or $480 per year, it would take about 2 ½ years to save $1,000. Interest paid on that savings would likely be at only about 1%, so your initial funding will come mostly from savings. One good fund that allows a $1,000 minimum is the Vanguard Star Fund with an average return of 7.6% over ten years. Once you have at least $3,000 in your IRA you can purchase the Vanguard index funds mentioned above.

You can increase your savings as your income increases and your nest egg can be a lot larger. Determine the investment mix that’s best for you and use a savings calculator to see how fast your money can grow based on the amount you can pay yourself first.

2. Get Your Free Money From Your Employer

If you who work for an employer that offers a retirement savings option, be certain you take full advantage of any employer match for that plan.

“If you are a typical salaried or hourly full-time employee in the United States, you’ve probably heard about your 401(k) plan. Fifty-two million Americans use them. Such plans held $3.5 trillion in retirement assets at the end of 2012. Folks who work in educational institutions have access to similar programs, known as 403(b) plans. State employees use 457 plans. They all do the same thing: Give you free money,” writes Mitch Tuchman. 

The first part of the free money is that your contributions are made with pre-tax dollars and lower your taxable income. Even better, many employers offer to match your contributions to the retirement savings plan. For example, an employer may contribute up to 6%, but that contribution is based on you making the same contribution out of your paycheck. You don’t want to leave that money on the table, so be sure to find out the details of your company’s retirement savings plan and try to put in enough money to match that employer guarantee. 

If you can’t afford to contribute enough for the full employer match, add to your percentage contribution each time you get a raise. For example, if you were to get a 4% raise, increase your retirement savings contribution by 1%. That way you still enjoy some increase in your pay, but pay yourself first as well. Since contributions to these retirement saving plans are tax-deferred, the actual amount of cash that will be taken out of your raise will be less than 1% depending on your tax bracket.

For more information, read 401(k) Plans: Roth Or Regular? and Smart Ways To Manage Your 401(k).

3. Self-Employed Retirement Saving Options

If you’re self employed, you have many different types of retirement savings options. These include a Solo 401(k), SEP IRA and Simple IRA. 

The Solo 401(k), also known as an Independent 401(k) is similar to the types of 401(k)s offered by employers. You can contribute money both as the employee and employer. That allows you to save as much as $17,500 if you are under 50 or $23,000 if you are 50 or older as the employee plus up to $52,000 as the employer ($57,500 if you are 50 or older). You can only use this plan if you are a sole proprietor. The only other employee you can have is your spouse.

The SEP IRA another option with similar contribution allowances, but it is simpler to set up. This type of IRA can be used by small businesses with employees, but the disadvantage can be that if you do decide to contribute, you must contribute for all employees who are part of the plan.

The Simple IRA is this third option for small business people or people who are self-employed. This, too, is easy to set up and operate but has lower contribution thresholds.

For more details on these retirement savings options read Retirement Planning for the Self Employed.

4. Traditional or Roth IRA

If none of the above options are available to you, start your own IRA. There are two types – a traditional IRA, which lets you save tax-deferred, and a Roth IRA, which you open with post-tax money. When you use a traditional IRA, you can deduct the amount you contribute each year from your income, but you will have to pay taxes on the money as you take it out. You pay taxes on both your contributions and any gains earned while the money is invested.

Although the money you put into a Roth IRA is after-tax cash, it means that when you take the money out at retirement, you don’t have to pay any taxes – either on the money you originally contributed to the Roth IRA or on the gains your money earned.

To figure out which IRA is best for you, read Roth Versus Traditional IRA: Which is Right for You?

5. Keep Control of Your Retirement Funds

When you change jobs, you’ll need to decide what to do with your employee retirement saving accounts. You’ll have the choice to cash them out, leave them with the employer (if the employer allows this) or roll them over into an IRA or, perhaps, into the 401(k) at your new job.

Rolling your employee retirement savings into an IRA is your best option: “Rolling money into an IRA opens the toolbox, so to speak, for the investor to invest in individual stocks, bonds – the whole range of investments is now available," says Daniel Galli, a Norwell, Mass., certified financial planner. With an IRA, you can choose how to invest the money, rather than being limited by the choices in an employee plan.

As your savings build, you may want to get the help of a financial advisor to determine the best way to apportion your funds. Some companies even offer free or low-cost retirement planning advice as part of their 401(k) programs.

6.  Think About Life in Retirement

As you begin to establish financial goals for your future, start imagining how you might want to live. Do you want to travel the world?  Is there a  business you want to start or a second career you've dreamed of exploring? Do you just want time to enjoy where you're living and get better at golf – or help your kids. Saving for retirement before anything else will give you the best chance of ending up with a nest egg that will enable you to support your family and your life. Your goals will change, but they probably won't be free. These changes don't have to wait until you hit 65 or 66. See Peri-Retirement: The New Life Transition.

The Bottom Line

Start saving for retirement as soon as you start earning income, even if you can’t afford much at the beginning. Paying yourself first is the most important habit you can develop if you want to enjoy a financially healthy retirement.

The savings methods you choose will depend partly on what your employer offers. But even if you are self-employed – or have no plans offered by your employer – you still have good retirement savings choices.