Saving for retirement is critically important — we all know that. But sometimes, the confusing details can throw us off course or prevent us from doing all we can to properly grow our nest egg.
Education is the best tool when it comes to most matters of personal finance. And for retirement planning, there are some facts everyone should know. It’s time to ask yourself these questions and brush up on the basics of retirement savings.
1. When can I start contributing to a retirement account?
With a traditional or Roth IRA, you can generally start contributing funds as soon as the account has been set up. However, rules can vary for employer-sponsored 401(k) plans. Some 401(k) plans may have a waiting period ranging from six to 12 months to make your first contribution, while others may allow you to contribute immediately. It’s a good practice to check all applicable rules for your workplace retirement plan at the time of sign-up and again during every open enrollment period. (See also: 8 Critical 401(k) Questions You Need to Ask Your Employer)
2. How much can I save in each type of account?
You can sock away the most money per year in a 401(k). In 2018, you can contribute up to $18,500 to a 401(k), and an additional $6,000 in catch-up contributions if you’re over age 50. By comparison, you can only contribute up to $5,550 to an IRA ($6,500 if over age 50). Due to its higher contribution limits, a 401(k) is a very beneficial account for those trying to make up for low savings in previous years or those close to retirement age. However, if possible, having both types of accounts is the even better option. (See also: 401(k) or IRA? You Need Both)
3. Am I taking advantage of the company match?
If you’re offered a company match, you must take advantage of it. And since 94 percent of Vanguard 401(k) plans provide employer contributions, chances are that you have access to a workplace savings plan with a matching formula.
A common formula for matching is $0.50 per dollar that you contribute up to 6 percent of your annual pay. This means that a worker making $50,000 per year could receive an extra $3,000 in employer matching contributions by contributing $6,000 of their annual salary into a 401(k). Some might say there’s no such thing as a free lunch, but an employer match on your 401(k) truly is a freebie. (See also: 7 Things You Should Know About Your 401(k) Match)
4. What happens if I change jobs?
From the date that you separate from your employer, you should aim to decide what to do with your 401(k) balance within 60 days. The reason for 60 days is that this is the deadline to complete an indirect rollover into a new retirement account (if your employer were to cash out your entire balance and hand you a check) and pay back any outstanding loans on your 401(k) (if not paid, they become taxable income and may even trigger penalties).
Under most scenarios, you have six rollover options for your total vested account balance:
Keep your account.
Rollover account into a new or existing IRA.
Rollover account into a new or existing qualified plan.
Do an indirect rollover.
Request a full cash-out of your account.
Do a mix of the above five options.
(See also: A Simple Guide to Rolling Over All of Your 401Ks and IRAs)
5. Is it better to contribute after-tax or pretax dollars?
There is no right or wrong answer here, as either way offers a benefit. Contributing with pretax dollars (traditional IRA, 401(k)) allows you to reduce your taxable income by deferring income taxes until retirement, at which point you’re more likely to be in a lower tax bracket. So, if you’re expecting to be making more money now than you will be in retirement, you should contribute pretax money. This is the majority of American workers.
Workers just beginning their careers, workers in professions with a high upside income potential, and individuals expecting a large windfall, such as a family trust or inheritance, can greatly benefit from contributing after-tax dollars to a Roth IRA or Roth 401(k).
6. Can I withdraw money early from my accounts?
Early distribution rules vary per type of plan.
Generally, you can only take money from a 401(k) plan early due to a hardship or extreme situation, such as avoiding a foreclosure, making a first-time home purchase, or an unexpected medical expense. However, rules vary per plan: Some plans may only offer you the option to take out a loan, while other plans won’t allow you to withdraw money early at all. If you take a distribution from a 401(k) before age 59 ½, you become liable for applicable income taxes and penalties.
There are several instances in which you can take an early distribution from a traditional IRA without incurring a penalty. This includes unreimbursed medical expenses, health insurance premiums during unemployment, the purchase of a first home, higher education expenses, and others. (See also: 7 Penalty-Free Ways to Withdraw Money From Your Retirement Account)
Early withdrawals on contributions from a Roth IRA can be made at any time without incurring taxes and penalties, since you have already paid taxes on the money. Withdrawing any amount that exceeds your contributions counts as earnings, and is therefore subject to tax and penalties. In order to avoid those taxes and penalties, your Roth IRA must be at least five years old and withdrawals must be used for a qualified expense, such as the purchase of a new home or a disability. Higher education costs are also exempt from penalties, but you must pay income tax on the withdrawals.
7. What are required minimum distributions?
Eventually, the IRS wants its money in the form of taxes on your retirement distributions. When you reach age 70 ½, you must begin taking required minimum distributions (RMDs) from your retirement plans. These rules apply to traditional and Roth 401(k) plans, as well as 403(b) plans, 457(b) plans, and traditional IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs. If you fail to take your RMD, the IRS will take 50 percent of the amount you should have withdrawn as a penalty.
The exception to the RMD rule is the Roth IRA, which is funded with post-tax dollars. (See also: Which of These 9 Retirement Accounts Is Right for You?)
8. Are there any tax credits for retirement contributions?
Come tax time, eligible workers can claim the Retirement Savings Contributions Credit, better known as the Saver’s Credit. Depending on your adjusted gross income (AGI), you can claim 50, 20, or 10 percent of your retirement plan contributions, up to $2,000 for single filers and $4,000 for married filing jointly. For example, a married couple with an AGI between $41,001 and $63,000 can claim 10 percent of their eligible contributions for the Saver’s Credit in 2018. (See also: Dumb 401(k) Mistakes Smart People Make)
9. What is the recommended 401(k) portfolio allocation?
Here’s some advice from one of the most successful investors of all time, Warren Buffett: Put 90 percent of your 401(k) balance in a very low-cost S&P 500 index fund, and the remaining 10 percent in short-term government bonds. Keeping true to his word, he has included this very same advice in his will. (See also: Bookmark This: A Step-by-Step Guide to Choosing 401(k) Investments)
10. What is an HSA?
Those with a high deductible health plan (HDHP) are eligible for a health savings account (HSA), which is a way to make pretax contributions to save for medical expenses. Many HSA providers offer the option to put money in an investment account with several fund options, including mutual funds and low-cost index funds.
The main benefit of saving for medical expenses using an HSA is that you won’t have to pay any income taxes on withdrawals used for qualifying medical expenses (even before retirement age). And when you do hit age 65, your HSA will basically become a traditional IRA. You can withdraw funds for any reason penalty-free, only paying income tax on the distributions. (See also: How an HSA Could Help Your Retirement)
11. Does my plan offer financial advice services?
More and more plans are jumping on the bandwagon of offering a robo-adviser (an automated service suggesting or performing certain types of transactions on your behalf). The range of trades that a robo-adviser can perform ranges from periodically rebalancing your portfolio to selling securities.
Fees can range, too: Some robo-advisers charge about 0.15 percent of your account balance or a flat monthly fee. Some plans may also offer you a-la-carte paid options to add a standard robo-adviser service. (See also: 9 Questions You Should Ask Before Hiring a Robo-Adviser)