It might seem like a long way away, but one day you’re going to retire. The best way to save for your golden years over the course of your working life is by contributing to an individual retirement account — a 401(k) or an IRA. The good news: Most companies offer 401(k)s for full-time employees, and anyone can open an IRA. The bad news: They can be confusing, complex, and intimidating.
Investment expert William Bernstein wants you to know that you, too, can navigate the stock market. His new book, If You Can: How Millennials Can Get Rich Slowly, helps make sense of the most important financial moves you will ever make in your life, and he’s offering it for free on his website. It’s shorter than any textbook and comes with additional reading assignments and exercises to fine-tune your investment know-how. Here, he gives a crash-course on how to navigate the 401(k) — and actually achieve a comfortable retirement.
How much money do I actually need to retire?
A good rule of thumb is to accumulate 25 years’ worth of “residual living expenses,” which is the amount you’ll need to live on after your Social Security, and any pension checks, come in. Let’s say you think you’ll need $50,000 per year to retire on, and that your Social Security payments will be $1,500 per month, or $18,000 per year. (Retirement benefits are determined by your income) In this case, your residual living expenses are $50,000 – $18,000 = $32,000 per year. So you’ll need to accumulate 25 x $32,000 = $800,000 to retire. This sounds formidable, but if you can save 15 percent of your salary in a retirement account from the time you’re 25 you should get there.
What exactly is a 401(k)?
It’s a retirement savings program for corporate employees. Typically, the employee defers a certain percentage of pre-tax wages into the plan and the employer will often match this up to a certain amount, which means they deposit the same amount into your account up to the limit they set. Not all companies match contributions, so you’ll need to check with human resources.
Is it worth it to have a 401(k) if my company doesn’t match funds?
Definitely. Usually. However, if you have a “bad” 401(k) and it doesn’t have a match, you may be better off putting your savings into a traditional or Roth IRA. Beyond that exception, the more ways you can save for retirement, the better.
What are the benefits of having a 401(k)?
The immediate benefit is the deferral of income taxes until after retirement, but the main benefit is that it allows the savings to grow tax-free until they are withdrawn. That means there’s more money to invest — and grow — during the life of the plan.
How does a traditional 401(k) differ from a Roth 401(k)? Is a Roth IRA the same thing as a traditional IRA?
With a Roth 401(k), you pay taxes up front on the money you invest, so you don’t pay taxes again when you withdraw the funds. The biggest difference between any 401(k) and IRA is contribution limits: in 2014, $17,500 for a 401(k) versus $5,500 for an IRA. The main difference between a Roth IRA and a traditional IRA are income limits. Individuals must have an adjusted gross income below $129,000 to qualify for a Roth IRA. Anyone can open a traditional IRA, though if your income is too high, the contribution may not be deductible.