*DISCLAIMER*: This website is for educational purposes only. I am not a CFP or financial advisor. Please consult a professional before making any financial decisions.
Saving for retirement was one of the most daunting tasks for me when I was 22. I was newly graduated from college, moving to a new state, and starting a lab tech job in the span of about a week, and I had very little room in my brain to think about my personal finances. Luckily, I had just become an employee of a large institution, which meant the framework for the university-sponsored retirement account (a 403(b), to be specific) was basically ready to go with a whole team of administrative staff who could help me set things up. I told them how much I wanted to contribute from my paycheck every month and that was that.
Once I started grad school, though, I was on my own. Getting funded from a large training grant meant that there was no 401(k) equivalent waiting for me, so I could only rely on opening an individual retirement account, or IRA. Since then, I’ve learned a lot (and made plenty of mistakes), and while I’m still no expert, I hope I can share some tips I wish I had known from the start!
Table of Contents
1. Why open a retirement account?
2. What the heck is a 401(k)??
3. How much should I contribute?
4. What investments do I pick?
5. Should I be saving for retirement or paying off my student loans?
6. Is it better to save a lump sum or a little every month?
7. How do I open an account?
Conclusion
References and Resources
1. Why do I need a retirement account? can’t I just use a savings account?
Two words: compound interest. A savings account is like a glorified, albeit insured, mattress to stash money in – it’s super important to have a liquid (easily accessible) emergency fund, but that’s not what retirement savings are for. Retirement accounts are like a cross between a savings account and a brokerage or investment account. Your contributions are usually protected (FDIC insured) like a savings account, but you’re able to invest that money and take advantage of compound interest as well as certain tax benefits. In fact, to discourage people from using them like a savings account, there are penalties for withdrawing money from your retirement account before you reach retirement age!
Example: compound interest
Sarah, Megan, and Veronica all want to start saving for retirement over 20 years:
- Sarah contributes $50 a month to her retirement account for 20 years.
- Megan contributes $100 a month to her retirement account for only the last 10 years.
- Veronica also contributes $50 a month for 20 years, but puts it in a normal savings account.
Let’s assume the retirement accounts yield 7%, while the savings account yields 0.25%. Below is a graph that tracks the growth of each account over time:
After 20 years, Sarah has $25,769, Megan has $17,170, and Veronica ends up with only $12,301! As you can see, time is very much on your side when it comes to investing for retirement, but always remember: no amount is too small to contribute and it’s never too late to start!
2. What are the different kinds of retirement accounts?
IRA
There are two main types of IRAs (individual retirement accounts) you can have regardless of where you work:
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- Traditional IRA: you can contribute pre-tax dollars to this and only pay taxes once you take it out after you retire; this one is helpful if you are in a higher tax bracket now than you think you’ll be at retirement; this one also helps if you have a crippling tax burden for some reason…
- Roth IRA: you can pay taxes now on the money you put in and not have to pay anything when you take it out at retirement; this one is helpful if you are in a lower tax bracket now than you think you’ll be at retirement
Both IRAs together have a maximum annual contribution limit of $6,500 (~$540/month, as of 2023). I’d highly recommend maxing out a Roth first since we don’t get paid that much right now 🙃, but you are allowed to have both if you want. Contributing to a traditional IRA can ease your tax burden a bit in the short term because you can deduct the contributions (see my Tips for Grad Student Taxes post!), but it’s better to prioritize the Roth first.
SUPER IMPORTANT!!!: when you open an IRA, make sure you actually choose an investment plan!! Some firms offer a pre-set plan depending on your risk tolerance, but some make you choose the investments yourself (more on this below). It’s CRITICAL to make sure this is set up because you don’t want to collect your retirement in 40 years and find that it’s effectively been sitting in a savings account (this happens to people more often than you would think).
Employer-Sponsored: 401(k), 403(b), etc.
Once you start working as an “official” employee somewhere, there are different options depending on the institution:
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- 401(K): this is the most common since it’s what almost all decently sized companies use. This one is great because it usually comes with an employer’s match (you should double check this with the company). Since you can potentially get thousands of dollars in free money, it’s super important to MAX OUT YOUR CONTRIBUTIONS!!! Even if you can’t afford to fully max it out, prioritize putting in as much as you can when you budget.
- 403(B): this account is like a 401(K) for nonprofit or public institutions like universities. Depending on your role and benefits, it may or may not come with an employer match. I definitely didn’t get a match when I was a lab tech.
There are several other flavors of retirement account, including the 401(A), the SIMPLE IRA, and more. If you’re interested in learning about these, check out this IRS page on them!
3. How much should I contribute?
I’d like to make a separate post in the future just focused on budgeting, so I’ll keep this brief. Experts bicker on an exact number, but total savings should generally be at least 20-25% of monthly income. I split this between my savings account and my retirement contributions as I’m still trying to build up an emergency fund. As an example, at the time of writing this, I contribute $445/month (~12% of my income) to my retirement accounts. Depending on your situation, it may be difficult to set aside the recommended amounts every month, but that’s okay! As we saw with the compound interest example, a little goes a long way, especially if you start early. Even if it’s 1% of your income for now, you’ll thank yourself later!
The answer to this question also depends on when and how you’d like to retire, if at all. Do you want to completely stop working at 65? 55? 45? Do you want to only work part time? Do you want to travel? These are all personal preferences to think about that may impact your saving strategy now. Check out this helpful chart from the Dollar After Dollar blog that breaks down savings rate and time to retirement.
4. What investments do I pick?
This depends on where you have an account. For example, my retirement accounts allow me to choose a risk level (from conservative to aggressive), and from there they will pick investments for me. Generally, younger people are encouraged to be more aggressive or take more risks with their investments because they have the time for compound interest to regain any losses. There is also the option to pick investments yourself. Again, I’d love to make a series of future posts all about investing, but for now I’ll emphasize the beauty of index funds.
In short, when you buy an index fund, it’s like buying a basket of lots of different stocks at once. It’s a very easy way to diversify your investments with minimal effort. If you are feeling overwhelmed by the thought of having to sift through the many funds that are out there, you can look into a total stock market fund like VTI. If you truly have no idea what you’re doing, the bank or firm that holds your account should have people who can answer your questions for free (Note: if they won’t answer your questions for free, I’d stay away from that bank!).
5. Should I pay off my student loans before thinking about retirement?
Experts also bicker about this question as well. Some will say that it depends: if your loan’s interest rate is lower than what you would expect as a return on your investments, then no. For example, let’s say the average return from a total stock market index fund is 7%. If your student loan interest rate is only 3%, mathematically it makes more sense to focus on your retirement savings.
HOWEVER, human psychology is also a factor here. Some people can’t stand to have any debt hanging over them at all. If not working to pay off your student loans will keep you up at night, nothing is stopping you from prioritizing that! I’m in the camp that believes you should be able to do both, so if you really want to knock out that debt, just contribute a minimum amount to a retirement account. My student loan interest is ~3-5% and my loans are in deferment because I’m in grad school, so I make minimal payments towards the principal every month and really focus on my retirement contributions.
6. Should I just invest a lump sum, or a little every month?
This question introduces a common dilemma of investing in general. If invested right before the market rises, a lump sum has the potential for huge returns. However, no one can predict the future and trying to time the market, especially for the average person saving for retirement, is an incredibly dangerous game. To combat this, there is a strategy called dollar cost averaging (DCA). By investing a bit every month, you are not only gaining exposure to a balance of high and low markets over time, but you have removed the temptation to time the market altogether! If you can stick it out no matter what the markets look like on a given day, you should see returns eventually. You can read more about DCA here!
Note: if you suddenly come into a large lump sum of money (i.e. inheritance, winnings, etc.), I’d recommend consulting a CFP or other fiduciary financial advisor to determine the best course of action for you.
7. How do I open a retirement account?
Most banks and investment brokerages will offer a variety of retirement plans, usually in the form of IRAs. You can open a retirement account the same way you would open a regular bank account. Banks want you to invest with them, so they should make the process relatively easy. You’ll provide some identifying information, connect a bank account, etc. Importantly, you’ll need to name one or more beneficiaries. This will likely be family members, spouse, children, etc., and you should be able to change it at any time.
Note: due to the Patriot Act, firms will likely require extra proof of identity before you can start contributing. I had to send a copy of my driver’s license TWICE before they let me do anything, so double check with them before you start adding money or it might bounce back!
Here are a few common banks/firms offering retirement accounts:
- Wells Fargo
- J.P. Morgan/Chase
- Fidelity
- Vanguard
- TD Ameritrade
Conclusion
The points listed above are just the tip of the iceberg when it comes to learning about investing for retirement! There are many topics that I didn’t have the space to cover in just one post, including how to roll investments over from one retirement account to another, how much money you “need” to retire (also known as “The 4% Rule”), and much more. The goal of this post was to cover the very basics and get you all thinking about steps you can take today to set yourself up financially in the future. Stay tuned for future posts that will cover other topics in investing and personal finance!
If you have any comments, questions, or suggestions, please leave me a comment down below!
References & Resources
IRS – Traditional vs. Roth: https://www.irs.gov/retirement-plans/traditional-and-roth-iras
IRS – Other retirement plans: https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans
Learn more about FDIC insurance: https://www.fdic.gov/about/
Dollar After Dollar blog: https://www.dollarafterdollar.com/category/invest/
Learn more about VTI: https://investor.vanguard.com/investment-products/etfs/profile/vti
Learn more about index funds: https://www.investopedia.com/terms/i/indexfund.asp
Learn more about Dollar Cost Averaging: https://www.investopedia.com/terms/d/dollarcostaveraging.asp
