4 Steps You Must Take to Fund Your 401(k) and IRA Retirement Accounts
We all know the importance of saving for retirement. It’s been hammered into us for years now.However, the number of people who do not understand how to fund their retirement accounts is truly surprising.
The right steps will help ensure that you get started on the right foot and have the nest egg you need when retirement rolls around.
The wrong steps might leave you with little or nothing.
What can you do?
Obviously, the first step is to realize that you need to save for retirement.
Next, you need to plan for retirement prudently, which means you need to determine what age you want to leave the workforce, the amount you’ll need to spend to live comfortably, and how much you need to save in order to reach those goals.
Now, it might seem like the next step would be to just start putting money into your retirement accounts, but that’s not actually the case.
The reason for this is simple – determining which of the many types of retirement accounts are right for you can be very hard to do. You have more than a few options, including IRAs, Roth IRAs, 401(k) accounts, 403(b) and 457 plans, deferred annuities and much more.
Which is right for you? What order should you fund them in?
For the vast majority of Americans, the default choice is a 401(k) plan. They’re good options for many needs and are relatively easy to understand. They also make great choices if your employer offers dollar-to-dollar contribution matching, essentially giving you free money.
IRAs are a little different. If you have earned income, then IRAs can be highly beneficial in boosting your retirement savings.
Retirement Accounts: The Differences
401(k) plans have higher contribution limits, and self-managed IRAs offer unlimited investment options.
401(k) plans and traditional IRAs offer upfront tax breaks with “qualified distributions,” while Roth IRA contributions cannot be deducted (although distributions are not taxed).
Ideally, you’ll use both a 401(k) plan and IRAs to fund your retirement, but we’ll break each down separately below for clarity.
Retirement Accounts: Steps to Funding
First, understand that 401(k) plans might be the most common type of retirement accounts in the US, but that doesn’t mean they’re the best. They tend to be somewhat costly. You’ll end up paying somewhere around $6.30 for every $1,000 you invest, according to an article on Bankrate.
Regardless, if you’re using a 401(k) plan, then you need to verify that your employer offers company contribution matching. Check with the HR department or your employee handbook for these details.
Many employers will match your contributions dollar for dollar up to about 6% of your annual salary. So, if you earn $50,000 per year, and you deposit $3,000 of that into your account, then your employer will match it with $3,000.
Next, you want to start looking at IRAs. You will need to contribute as much as you can here. You can opt for either a traditional IRA or a Roth IRA (if you’re in a lower tax bracket, then a Roth IRA is the better choice, but this also works if you have a high income and your contributions to a traditional IRA are not deductible). Max out your contributions here.
Now, you need to take another look at your 401(k) plan.
If you have money left over after contributing to your 401(k) the first time and your IRA, it’s time to put some more into the 401(k) plan, even if you’ve already maxed out your available employer matching. You can contribute up to $18,000 per year in this account, which is significantly higher than what you can add to an IRA. If you’re over 50 years of age, you can contribute up to $ 24,000 annually.
In addition, remember that anything you add to this account enjoys tax-free growth, meaning you can protect it from the IRS.
As a note, if your employer does not offer contribution matching, you should reverse the steps above and choose an IRA first before considering a 401(k) account.
While many employers do offer contribution matching, it’s not a universal practice. In this case, pick an IRA and then max out your contributions for the year.
Then, you can start your 401(k) plan after you’ve maximized the benefits available to you through an IRA.
When everything is said and done, you need to save as much for retirement as possible. Remember that the future return on any investment might be very low, so the sooner you start saving, and the savvier you are with your retirement accounts and how you fund them, the more stability you will enjoy in retirement.
It’s highly recommended that you save at least 20% of your annual income, but more is definitely better.
To achieve this level of savings, many people will find that they need to live below their means. That can be a challenge at first, but spending less and earning more can have a profound effect on your ability to live comfortably in retirement, or even retire early.
Also, you should understand what types of retirement accounts you should use and where your money should be allocated.
While stock market booms may make this an attractive option, remember that volatility can devastate your savings. Individual bonds provide a reliable return for investment portfolios.
Also, income from interest received on bonds is taxed as ordinary income, rather than capital gains, so it is wise to maximize your bond holdings in IRA accounts. Stock holdings should be maintained in general investment accounts.