In this article we explore ways to help ensure that you’ll have the income you need for your future.
Most people have good intentions when it comes to investing for retirement. But with immediate financial needs like mortgage or rent payments, student loans, credit card debt, and everyday expenses claiming a share of your paycheck, it’s easy to let planning for the future fall behind on your list of financial priorities. “When you’re younger, the temptation is to defer retirement savings because you won’t need the money for another several decades,” says Christopher Vale, senior vice president, Merrill Edge Product Strategy. “But by getting started now, you’ll make it a lot easier to get to whatever goal you choose for when you retire.”
Here are six steps you can take to help you prepare for your future.
Step 1: Treat your retirement savings as a monthly expense
“Take that money off the top of your income, not from what’s left at the end of the month,” suggests Debra Greenberg, director, Personal Retirement Strategy and Solutions at Bank of America Merrill Lynch. “You’ve probably heard this advice before, but it’s a mind game that really works.” Next, look at your budget to identify areas where you can free up more money to save. Seemingly small savings—like finding a better deal on your cable or cell phone service—can really add up.
Step 2: Get into the 401(k) routine
Enroll in your company’s 401(k) plan as soon as you can to take advantage of the benefits it offers. Your contributions are automatically deducted from your paycheck, making it easier to maintain the discipline of contributing.
Traditional 401(k) contributions are made with pre-tax dollars and are taxed when you withdraw them. In addition, some employers offer Roth 401(k) contributions, which can potentially be advantageous for younger investors. Although Roth 401(k) contributions are made with after-tax income, withdrawals during retirement won’t be taxed at the federal level if taken as qualified distributions.1 This may be especially beneficial if you expect your tax rate later in retirement to be higher than your current rate.
Your employer may even match a certain percentage of your 401(k) contributions. If that’s the case, try to contribute enough to earn the full match. “An employer match is part of your compensation, so don’t leave that money on the table,” says Vale.
Step 3: Consider an IRA
If you’re contributing the maximum to your 401(k) account and want to save even more, think about investing in a traditional or Roth IRA.
With a Roth IRA, you can contribute after-tax dollars without paying federal tax on your earnings when you withdraw them at retirement, as long as they’re taken as a qualified distribution. Consult with your tax and/or legal advisor about possible state tax consequences related to Roth contributions.
In the case of a traditional IRA, you may be eligible for a tax deduction now, but you’ll be taxed when you withdraw the assets later. This can potentially work to your advantage if you’re currently in a tax bracket higher than the one you’re expecting to occupy during your retirement, when you’ll have to pay tax on withdrawals. Ask a tax advisor to help you decide which IRA may be right for you.
A little could go a long way
The more you contribute to your retirement plan, the better prepared you could be for retirement. Increasing your contribution rate by even 1% could make a difference over the long term.
Assumes a salary of $40,000, contribution rates of 4% and 5% with contributions made at the beginning of the month and a 6% annual effective rate of return. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than their original cost. Taxes are due upon withdrawal. If you take a withdrawal prior to age 59½, you may also be subject to a 10% additional federal tax.
Step 4: Build on your successes
Especially when you’re starting out, contributing as much of your income as you can toward retirement may make sense, considering that future health care costs and inflation could add up to more than you think. If you can’t contribute much right now, stretch as far as you can, and commit to increasing your contribution when you get a raise or pay off a large expense. Even raising it by 1% or 2% can add up. If your company’s 401(k) plan offers an automatic increase feature—which regularly increases your contribution rate over time—consider signing up.
Step 5: Consider keeping all your accounts under the same roof
It can be much easier to keep track of your retirement funds and monitor an overall asset allocation when all of your retirement accounts are in one place. If you’ve left retirement funds in previous employers’ 401(k) plans, you’ve got a number of choices for keeping those assets. You can leave them in your former employer’s plan, move the assets to your current employer’s plan, roll your assets to a traditional or Roth IRA, convert pre-tax assets to a Roth IRA, or take a cash distribution.
Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, and tax treatment. They may also provide different protections from creditors and legal judgments. These are complex choices and should be considered with care—a financial professional can help you understand your options.
Step 6: Avoid taking early withdrawals for non-retirement-related expenses
Of course, investing for retirement isn’t your only focus—you may also save for your child’s college costs or put away money for emergencies. By balancing retirement planning with those other needs, you can avoid dipping into your retirement accounts—something you really don’t want to have to do.
Usually if you’re under age 59½ and withdraw retirement account funds, you’ll have to pay taxes on any pre-tax assets you withdraw, including earnings on Roth contributions, and on top of that a 10% additional federal tax may apply unless you qualify for an exception. Ask your tax advisor about the rules of using those funds for education or the purchase of a home, and be aware of how withdrawing those funds can affect your future retirement income.
Once you’ve established a retirement savings strategy that also accounts for your other financial priorities, you’re on your way. Stick to your plan, and monitor it regularly to be sure it continues to align with your goals as they evolve. By the time you retire, you’ll be glad you started investing as much as you did as early as you did.
1 Any earnings on Roth 401(k) contributions can generally be withdrawn tax-free if you meet the two requirements for a “qualified distribution”: 1) At least five years must have elapsed from the year of your initial contribution, and 2) You must have reached age 59½ or become disabled or deceased. If you take a non-qualified withdrawal of your Roth 401(k) contributions, any Roth 401(k) investment returns are subject to regular income taxes, plus a possible 10% additional federal tax if withdrawn before age 59½.
Investing through your plan involves risk, including the possible loss of principal invested.
Neither Merrill Lynch nor any of its affiliates or financial advisors provides legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Merrill Edge, available through Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S”), consists of Merrill Edge Advisory Center (investment guidance) or self-directed online investing.