You probably don’t think a lot about retirement other than the question “do I want to have a house in Europe, one in Hawaii, or both?” And retirement is probably a ways away for you. But it’s important to think about starting to plan and save for retirement now.

This article will show you why saving for retirement is so important and what the different options are based on your income, savings, employment status, and estimated time remaining before retirement.

No More Full-time Job, but the Same Expenses!

While you won’t be working (as much), many times retirees need to increase their expenses as healthcare can be quite expensive and the elderly generally spend more on healthcare than their younger counterparts. So, how do you pay these costs if you are no longer an employee of your company?

1. You could just rely on the funds in your bank account. That can work, but at some point, you will run out of money even if you have $1,000,000 there when you retire!
2. Social Security Income is another source and for most current and past retirees, this has been a dependable source.
   • However, according to the latest report for the Social Security Administration, the fund that pays retirement benefits will run out of funds by 2035, after which point only 77% of benefits will be able to be paid. While it is unlikely that the funds will run out completely, 73% of Americans believe Social Security will run out before they retire.
3. If you are lucky enough to have a pension, this is a great source of income.
   • However, only 17% of private industry workers were offered a traditional pension plan as of 2018. Most workers who still receive pensions are teachers (89% below college-level and 59% of college-level employees), nurses, and those who work for the government, military, protective services, pharmaceuticals, transportation, and utilities, as well as union employees.
4. Many people find they do not wish to fully retire and have either a part-time job or some sort of passive income stream. This is a great way to supplement your other income sources and keep your mind busy, which has all sorts of health benefits.
5. Arguably the most important source is your retirement accounts. Unfortunately, only 41% of workers contribute to a 401(k) account, though 68% have the opportunity to do so. Even more discouraging, only 10% of taxpayers had a Roth account as of Tax Year 2017.

Not sure what these are and why you should have both? That’s what this article is for!

Roth IRA:

Let’s start with the Roth IRA account, arguably the best way to save for retirement early in your career.

The beauty of a Roth IRA is that the money which you put in is after-tax, which means that if you put in $5,000, you can withdraw up to $5,000. If you have $5,000,000 at the time of retirement, you can take it all out if you’d like to. Once the money enters the account, it is safe from taxation; the initial investment and the subsequent gains you earn are all tax-free. Simply put, the money in the Roth is your money and yours alone!

Now, because Uncle Sam doesn’t want to lose tax revenue, you must contribute after-tax money. So, if you have an extra $5,000 in your bank account, you can certainly contribute it to your Roth IRA. However, you cannot deduct this amount from your paycheck before paying taxes– you must pay income tax on this money first. And in 2022, the income limit is $214,000 in combined income for married couples filing jointly and $144,000 for single people or those married filing separately. If you earn more than those amounts, you are not eligible to contribute to a Roth. Also note that if you earn less than $6,000 in a year, you are only eligible to contribute up to the level of income that you earned that year.

You might think those are large salaries, and you’re right, but I assume you are interested in being successful. If so, won’t you earn more by the time you’ve “made it?” If you can afford it, make every effort to contribute $6,000 to your Roth each year until you phase out. Let’s examine why (and why you should invest in the first place).

401k:

A 401(k) is one of the most common type of retirement accounts. Every company has slightly different programs, but here are the basics:

• A part of the benefits package your company offers, you have the opportunity to contribute a certain amount of your paycheck to a retirement account sponsored by your firm
• This can be pre-tax or after-tax, I’ll explain about this difference in greater detail below
• You may receive a match from the company.

This “match” is an amount that your employer agrees to contribute to your account, on your behalf. It may be:

• 100% match (usually up to 3% or 5% of your income)
• 50% match (up to a higher amount).
  • You would receive $0.50 per $1 you contribute up to the limit. So, if you have a 50% match up to 10%, that means to receive a full 5% of your salary matched from your employer, you must contribute 10% of your income to the 401k.

Another employer-specific nuance is the vesting period. This is the period before which the employer match amount is yours to keep, no matter what. If you were to leave your company or get fired before then, then only the vested amount is yours to keep. Got it?

For more on the 401k, I devoted an entire article to explaining the rollover process.

It’s time to talk about two of the most exciting topics: math and law!

Perhaps you’ve heard about the magic of compound interest. If not, here is a quick explanation:

• Let’s say you have $100 and can earn 5% interest each year. 5% of $100 is $5 (100*.05), so you may think that you’ll earn $5 each year and 30 years from now, you will have $100 + $5*30= $250.

That’s not quite right. Let’s examine this:

• In the first year, you will earn $5, so at the end of the year, you’ll have $105.
• 5% of $105 is $5.25, so at the end of the next year, you’ll have $110.25, not $110. Not a big difference.
• But what about thirty years from now? You will have $432.19, not $250. How did I get this number? The value = Initial Amount (1+interest rate)^time. If you plug in the numbers, it looks like this 100(1+.05)³⁰= 432.19.

That’s it for the quick math lesson!

Why did I show you this? That was only $100. If you contribute $6,000 just once and assume 5% annual returns, you’d have $25,931.65 after 30 years. And remember, this is your money, no taxes involved! Now just imagine you do max out the Roth each year for 10 years before your income rises above $144,000 or $214,000. $60,000 with 5% annual returns for 30 years is $259,316.54!

Hopefully this has convinced you that the Roth IRA should be something that you contribute to each year you are able to do so. Why did I assume 5% growth each year? The S&P 500, a weighted collection of 500 leading publicly traded companies in the US often used as a proxy for overall market returns, has yielded an average annualized return of 10.67% since its expansion to 500 stocks in 1957. Even adjusting for inflation, this number is roughly 7%.

Let’s assume conservatively that your returns are worse than the S&P 500. Even if they are 2% worse after accounting for inflation, you can still have staggering returns thanks to compound interest!

It is extremely important to note that investing inherently is risky. You will not have 5% returns each year. In fact, it is highly unlikely that any year will have exactly 5% returns. After all, the returns for the S&P 500 in the year 2021 were 26.89%. In 2020, they were 16.26. However, as of July 18^th, the S&P is down 19.62% in 2022. The past is never a predictor of the future and there is a possibility that returns might be lower in the next 30 years.

However, what are the alternatives? The best interest rate at a bank might be 2% but there are all sorts of terms and conditions, such as the amount deposited, number of withdrawals allowed per month, etc.

How Does this Affect You?

It’s nice to show the S&P 500’s returns, but you might wonder how your real-life investments will work. Do you need to buy 1 stock of each company in the S&P 500? The answer to that is a definitive no. Diversification is extremely important in investing. There are many, many different investing approaches. A future article will give general pointers and explain the differences between mutual funds, ETFs, and individual stocks and bonds.

Evan