As if figuring out how to save for retirement weren’t difficult enough, you also have to decide where to save. Is your 401(k) a good choice? Should you put your money into an IRA or a Roth IRA? What about the alphabet soup of other options: SEP, SIMPLE, ESOP, and so on?
If you’re just getting started with retirement savings, the choices can feel overwhelming. There’s a smart way to go about this, though. You just have to understand a few key details about your situation and your current options.
Check Your Stats
In a 2015 survey conducted by the Employee Benefit Research Institute, only 48 percent of workers reported that they’d attempted to calculate how much money they should be saving for retirement. And that’s too bad, since those who do try to come up with a number wind up saving more than those who don’t, according to last year’s report.
There are many retirement calculators, but Choose to Save’s Ballpark Estimate is a good place to start. Enter a few figures (your age, your salary, your current retirement savings, and when you want to retire, among others) and you’ll get an estimate of the percent of your income you need to save.
Or you can use AARP’s more sophisticated calculator, which lets you take into account a partner’s earnings, savings, and Social Security benefits. If the number seems scarily high, don’t panic. Anything you save will help you in retirement. Start where you can, and boost your savings as you go.
Now that you have your number, your next task is to figure out where to put it.
Get Your Match
It’s virtually a no-brainer: Don’t pass up a chance to invest in a 401(k) or 403(b), especially if your company offers a match. Matches are free money, and you should do whatever you can to make sure you get every dime your company is willing to give you.
Even if your plan doesn’t have a match, your contributions reduce your taxes and the money can grow tax-deferred until retirement. Your plan also may offer institutional investment options that are cheaper than anything you could buy on your own. You might decide to put some of your retirement savings elsewhere, but your first step should be signing up to contribute to your workplace plan.
Federal law allows contributions up to $18,000 in 2015, plus an additional $6,000 “catch-up” contribution for people 50 and over. Your plan may have lower limits, however, so read the fine print or talk to HR.
No Workplace Plan?
If you don’t have a workplace plan, you should consider funding an IRA. Even if you are covered by a plan at work, you may still want to put a few bucks here. (You can contribute up to $5,500 in 2015, or $6,500 if you’re 50 or over.)
Anyone who has earned income (wages, salary, or self-employment income) can contribute to an IRA. If you have a traditional (not a Roth) IRA, you can deduct those contributions if you aren’t covered by a workplace plan or if you’re covered but your income is below certain limits. Your money grows tax-deferred until you withdraw it in retirement.
IRAs typically allow you to choose from a much wider array of investments than most workplace plans offer. If you set yours up at a brokerage firm, you’ll have access to thousands of options, including individual stocks and bonds, which you typically won’t find in a 401(k) or 403(b). That diversity is why some people contribute to both workplace plans and IRAs. If you can’t deduct your IRA contribution because of your employer plan or income, you should consider a Roth IRA instead.
Go Tax-Free Down the Line
You can’t deduct your contributions to a Roth IRA, but the money can come out tax free in retirement. That’s a powerful incentive, especially for young people, who are likely to be in a higher tax bracket in the future. Some financial advisors recommend you put at least some money into a Roth IRA if you can, since you’ll have more flexibility to manage your tax bill in retirement.
Roth IRAs also don’t require you to make withdrawals during your lifetime, which means they can be vehicles to pass money to your children if you don’t need the funds. (Regular IRAs, by contrast, require withdrawals starting at age 70½).
Your ability to contribute to a Roth starts phasing out when your modified adjusted gross income reaches $116,000 for singles or $183,000 for married couples filing jointly.
Supplement That 401(k)
Also known as 457 plans, deferred compensation plans have tax advantages similar to 401(k)s but don’t have the same restrictions on withdrawals, and they’re offered by state or local government or certain tax-exempt organizations. You can take the money out at any time and pay income tax but not penalties. (Early withdrawals from other retirement plans typically incur a 10 percent federal penalty.) If your employer offers a 457, it will be in addition to a more typical retirement plan.
You can put up to $18,000 into a 457 in 2015, and you may have catch-up options, depending on the plan.
One downside is that you have fewer rollover options if you leave your employer. While 401(k)s can be rolled over into IRAs or 403(b)s, 457s can be rolled over only to other 457s or Roth IRAs. If you leave your employer and don’t have a rollover option, you would have to cash out. Also, investments in 457 plans are often annuities, which tend to come with high expenses and surrender charges. Those disadvantages mean a 457 shouldn’t replace your 401(k), but might supplement it.
Stocks at No Cost
ESOPs offer workers shares of the company, typically at no cost. (They’re different from employee stock purchase plans, which usually sell discounted shares.) Since it’s essentially free money, there’s no reason to turn it down, if your company offers one.
ESOPs aren’t guaranteed money, however. The stock value can drop to zero if the company goes out of business, and may take big dives that reflect the company’s prospects or the stock market in general. That’s why you shouldn’t rely on ESOPs for your retirement, but instead see them as a supplement to other retirement funds.
For the Self-Employed
If you have a side business or are entirely self-employed, you may have several more options for retirement savings: Simplified Employee Pension (SEP), Savings Incentive Match Plan for Employees (SIMPLE), and solo 401(k)s, among others. SEPS let you contribute up to 25 percent of your net earnings, up to $53,000 for 2015. SIMPLEs allow you to put in all your net earnings, up to $12,500, or $15,500 if you’re 50 or over. The limits for solo 401(k)s are the same as for workplace plans: $18,000, or $24,000 if you’re 50 or over.
Another option, if you’re making a lot of money, is a traditional defined benefit pension. You may be able to contribute $215,000 or more to such plans, but they cost a few thousand dollars to set up and administer each year. To get started, you typically hire a CPA and an actuarial firm, and then set up an account at a brokerage firm.
The right plan depends on a number of factors, so discuss your options with a tax pro.
Save Even More
If you’ve maxed out all your other retirement options and want to save more, consider setting up a brokerage account for additional investments. You won’t get a tax break for contributions, but you can qualify for lower capital gains tax rates on investments you hold for at least a year.