Congratulations, you are now debt free and have your emergency fund set. You are right in the middle of the JAM program. Now is the time for true wealth building in Phase 2, Simple Step 2: Retirement savings.
I suggest putting 10%-15% of your total income towards retirement. 10% should be the goal if you are 40 years old and under and 15% if you are older than 40.
This step leaves a few questions that need to be answered on how to invest this 10-15%. I have listed 3 priorities to maximize your retirement contributions. If your employer does not offer a retirement plan, skip step one and go directly to step two.
- Contribute up to your employers match. If your employer matches any part of your retirement contributions: do this first and contribute up to the matched amount. They are giving you free money. Even if it takes some time to become fully vested (it’s not a type of sweater), use this contribution option first. My company matches up to 4% of my 401k contributions. Therefore, an automatic 4% goes into my 401k, no questions asked. Once that is complete, move to step 2.
- Roth IRA contributions. Unless you are 55 or older or you are in an unique situation, a Roth IRA contribution should be your next priority after receiving free money from your employer. Roth IRA’s can be withdrawn tax free, making this the best long term retirement investment vehicle available. In 2010, you can contribute to a Roth up to $5,000 a year, per person if you are 50 years old or younger and up to $6,000 if you are 50 or older. There are some restrictions for Roth contributions if you make too much income (more than $167,000 Modified AGI if married and $105k if filing single) or did not make any income in the contribution year. Here is the link to the IRS on Roth Eligibility. http://www.irs.gov/retirement/participant/article/0,,id=188238,00.html
- After you’ve tapped out your employers match and your maximum Roth IRA contribution, go back to your employer’s retirement plan (401k/403b) and contribute up to your overall 10-15% of your retirement savings. If you have contributed over $5000 to a Roth, do not contribute to a traditional/rollover IRA. Your maximum 401k contribution limit is $16,500 in 2010, allowing you to go back and contribute money in addition to your Roth IRA.
3a. If you do not have an employer retirement plan and have contributed $5k to a Roth IRA, your best plan to invest your additional retirement savings into a taxable non-retirement brokerage account. This is not tax sheltered, but you can still save for retirement in an account that is not labeled a ‘retirement account.’ These accounts are easy and cheap to set up with a discounted brokerage firm, such as E-Trade, Fidelity Investments, or Charles Schwab. www.etrade.com www.fidelity.com www.schwab.com
Let’s Put This into Practice with a Couple of Examples
Jim – 35 Years old, Single Earns $85,000 and has an employer offered retirement plan with a 3% match (at 10%, he will be making $8,500 in retirement contributions.) Here’s how his contribution breakdown would work:
- 401k – 3% match = $2,550 (3% of $85,000.00)
- Roth Contribution – $5,000 (Jim is eligible as he makes less than $105k)
- Additional 401k Contribution of the remaining $950.00.
Jennifer – 25 year old single, earns $60,000 ($6k contributions), no employer retirement plan.
2. Jennifer skips step one and contributes $5,000 into a Roth IRA.
3. The additional $1000.00 goes into a taxable non-retirement brokerage account since she has no employer retirement plan.
Setting these three Priorities up is not as difficult as it looks. Simply set up a direct deposit for each step and forget it.
Disclaimer: Please note this is a very broad outline of retirement contributions and leaves out a lot of details that may be pertinent to your situation. Please speak with your accountant/tax advisor with if your situation falls outside the guidelines mentioned in this post.
