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Retirement

Employer-Sponsored Retirement Plans: Take Advantage Early

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October 5, 2017
Employer Benefits

If you’re just beginning your career, you might have prioritized paying off college debt and building emergency savings rather than retirement. Ironically, though, retirement is one of the first things you should consider. If your job has an employer-sponsored retirement plan, it can pay to take advantage early on to benefit from the power of compounding.

Even if you’re a veteran of the workforce, have children, and are juggling multiple financial obligations, remember to make retirement a priority. Though it may sound selfish, many financial experts say put yourself and your retirement first, even if it seems like so many other things are higher priority at the moment, like college savings, or buying new home. If you’re in your 30s and 40s and haven’t started contributing to your company’s retirement plan, it’s still not too late. And if you have one now, keep contributing. 

If your employer offers a 401(k) retirement plan, it will automatically pull money from each paycheck before taxes and put it to work in the investments you choose. Consider making as big a contribution as possible each month—taking contribution limits into account. Some firms will match a percentage of your contribution, so be sure to take advantage of this benefit to add to your savings.

Compounding is when your initial investment grows along with your interest on the initial investment, giving your money the chance for more growth over time. That’s why it can help to start making your contributions as early as possible, though it's important to remember that investments don't always grow, and could lose money.

“When you’re 25, being 50 is outside of most people’s thought process, but one of the greatest investments you can make for yourself is to start putting money away at that age,” said JJ Kinahan, chief market strategist at TD Ameritrade. “It should be an investment in the future of you.”

Understanding Compound Returns

Kinahan calls compounding “one of the miracles of the world.” And young investors can potentially benefit more than anyone. Because of compounding, those who start early potentially can end up with a lot more money in the end. Simply put, getting the most out of compound interest means investing as early as possible in life. The longer you wait to start saving for retirement, the more you miss out on the benefits of compound interest.

Consider this example of someone who begins investing $5,000 a year at age 22 and continues to put that amount of money away until they retire at 67, earning an average 6% return. They’d end up with twice the money as an investor who did the same thing starting at age 32. It could mean the difference between retiring with half a million dollars vs. retiring with $1 million, according to a New York Times analysis. That’s the power of compound returns.

That might sound discouraging if you’re already in your 30s or 40s and haven’t gotten started, but the same rule still applies about earlier being better. Compound interest still can often provide an advantage for those who start investing at 40 over those who wait until they’re 50, and for those who begin at 50 instead of waiting until they’re 60. You might need to put more money into the pot, however, than someone in their 20s if you want a chance to build a significant savings.

Deciding How Much To Contribute and then Adding To It

One thing you’ll need to decide is how much to contribute. You might want to consider investing as high a percentage of your income as your employer will match, as this can help you potentially get the most out of the matching contribution. For instance, if your employer will match a maximum of 3% of your contributions, consider contributing at least 3%. This may still apply even if you’re in debt, because, as financial experts often note, it's "free" money.

Additionally, if you contribute to any other outside accounts, such as a Roth IRA, try to contribute the maximum $5,500 a year to that account before adding any amount to your 401(k) above the employer match level. The Roth IRA can be an important option because it provides you tax-free cash in retirement. That's because with a Roth, you pay taxes when you contribute.

If you get a raise, it might make sense to devote part of it to your 401(k) contributions. You probably won’t even miss the money because it never hit your savings or checking account.

Beyond the 401(k)

Other employer benefit plans include 403(b) and 457 plans, which often are available if you work for a non-profit institution like a school, religious organization, or charity. Just like a 401(k), these plans can usually be rolled over to an IRA if you leave your employer.  Make sure you know what the match or other employer contribution rules are, so you can max-out the match or other contributions.

If you’re self-employed, freelance, or have a side gig, an SEP IRA might be an option, allowing you to contribute up to 25% of your self-employed/side gig income with no commitment to contribute each year. 

“SEPs should be considered if you're self-employed” said Christine Russell, Sr. Manager Retirement, at TD Ameritrade. “SEP contributions are flexible, plus you might save on taxes by contributing."

Or if you want to put away more than 25% of you self-employed income, check out the solo 401(k), where the current maximum individual contribution for 2017 is $18,000 plus 25% of your compensation. While you may want to talk to a financial services or tax professional about what plan is best for you, actually setting up these small business plans is fairly simple, especially if you have no employees.

If your employer doesn’t offer a plan, consider fully funding an Individual Retirement Account (IRA) or Roth IRA up to the current maximum of $5,500 a year. If you are married and one spouse doesn’t work, the worker can typically put in the $5,500 for the non-working spouse. There are some nuances based on income and personal situations, so be sure to talk to your tax-planning professional. Some financial services firms can help explain the rules to help you feel more comfortable and attempt to get the most from your retirement plan.

Don’t Forget the Yearly Check-up

Once you’ve set up your 401(k) or other employer-sponsored retirement plan, remember to check it every year to make sure your investment mix is still where you want it, and consider adding additional contributions from any pay raise you might have received. Keep an eye on the balance between equities and fixed income investments in your portfolio, because a rising stock market can sometimes push you above where you might want to be from an equity/fixed income balance perspective. Consider re-balancing each year if necessary.

Also keep your savings goals top of mind. If you find yourself saving large amounts for nearer-term needs like a down payment on a car or home, don’t neglect your own retirement needs. As many a financial professional has said, you can borrow for college, but a bank isn’t likely to loan you money for retirement.

All investing involves risk including the possible loss of principal

TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your retirement account. 

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