The phrase “the future looks bright” is a common way to express optimism about the future. But what exactly does it mean?
401(k) plans have become one of the most popular ways to save for retirement. They offer employees many investment options and often feature employer-matching contributions.
How Much Money Do You Need to Save for Retirement?
You will need to save a significant amount of money to sustain your lifestyle in retirement. How much you need depends on your planned retirement age, how comfortable you want to live in retirement, and the rate of return on your investments.
For example, if you plan to retire at age 60, you must save the equivalent of your salary by age 30 and three times your salary by age 40. At age 50, you should have protected eight times your final paycheck, and by age 67, 10 times your final income. These are guidelines developed by investment firm Fidelity, and they are based on the assumption that you are saving 15% of your salary each year beginning at age 25 and investing most of that money in stocks, which typically have higher returns than bonds or cash.
If you have debt or a high cost of living, it might take longer to reach your savings goals. But you can help yourself by setting up an emergency fund to cover surprise expenses. This will keep your retirement savings from being depleted by unplanned events or repairs.
Another critical step is to compare your current budget to your estimated future expenses in retirement. You can save more or adjust your spending habits, improving your chances of reaching your savings goals.
Do You Have Other Investments or Retirement Accounts?
Throughout your career, you’ll likely accumulate retirement savings in various accounts. If you can access an employer’s retirement plan, such as a 401(k) or 403(b), ensure you take full advantage of it. Especially if your employer will match your contributions up to a certain percentage, that free money can help you grow your nest egg even faster.
Beyond that, a traditional individual retirement account (IRA) provides flexibility to save more with tax benefits. Depending on your circumstances, you can choose between an upfront tax break in the year you contribute to an IRA (via a traditional IRA) or a back-end tax break that makes withdrawals tax-free in retirement (via a Roth IRA).
Defined contribution plans, including safe harbor 401k plans, have replaced traditional pension plans in the workplace. These accounts allow employees to save for retirement through payroll deductions and invest in the funds of their choice, usually a mix of stock and bond mutual funds. Many 401(k) providers also offer target date funds that manage investments based on your desired retirement timeline.
In addition to IRAs, other investment accounts include self-directed IRAs such as Simplified Employee Pension IRAs and Solo 401(k)s, which are available for those who work for themselves or have side income through freelance or consulting jobs. Education and ABLE accounts are other types that can help you save for college tuition and disability-related expenses.
Do You Need to Draw from Your 401(k) Right Now?
While saving for retirement is a priority for most people, drawing from those savings promptly, if needed, is essential. Fortunately, there are several tax-free withdrawal options for retirement accounts.
The money you contribute to a traditional 401(k) is deducted from your paycheck before taxes are applied, which lowers your taxable income and helps reduce your spending in retirement. However, if you withdraw funds from your 401(k) before reaching age 59 1/2, you will be subject to ordinary income taxes on the amount you start, plus a 10% penalty unless you meet one of the following exceptions:
You can take loans out of your 401(k) plan if you need them, but you must repay the loan with interest within a specific time frame, and it will deplete any compounding that would have occurred otherwise. The IRS also allows you to withdraw funds from a 401(k) plan without paying taxes and penalties in the event of a covered life-changing circumstance, such as a disability or a terminal illness. A financial professional can help determine if these situations are appropriate and how much you may need to borrow. They can also assist you in deciding how much you can safely spend in retirement, a complex calculation that should be personalized to your unique circumstances and retirement goals.
Do You Want to Roll Your Assets into an IRA When You Retire?
Once you retire, you must decide what to do with your 401(k) assets. Typically, this means rolling them over into an individual retirement account (IRA). This will continue to provide you with tax-deferred growth.
Unlike an IRA, which anyone can open, you can only contribute to a 401(k) through your employer. Most employers also match a portion of employee contributions to their plan. So, it is essential to understand the rules of your employer’s 401(k) and ensure you take advantage of all the benefits the program offers.
When saving money in a traditional 401(k), the money is taken out of your paycheck before taxes are applied, lowering your taxable income. However, when you withdraw the funds in retirement, you pay taxes on the contributions and investment earnings.
Many 401(k) plans offer a selection of investments you can choose from, and your employer may set up a default asset allocation for you. However, it’s a good idea to review the options available and adjust your portfolio in line with your risk tolerance and time to retirement goals. For example, you should shift from an 80% stock to a 20% bond mix as you get closer to your goal date. This can reduce the potential for market losses in the last few years of your retirement.
Arman Ali, respects both business and technology. He enjoys writing about new business and technical developments. He has previously written content for numerous SaaS and IT organizations. He also enjoys reading about emerging technical trends and advances.