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Maximize Your Retirement Savings with IRAs

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Americans don’t like to think about retirement. According to a recent report by the Federal Reserve, 6 in 10 respondents who aren’t retired yet and have a self-directed retirement plan, such as an individual retirement account (IRA) or a 401(k), don’t feel comfortable making investing decisions.

This discomfort with key retirement decisions can be blamed in part on the fact that many Americans don’t have the right savings strategy for retirement. Let’s take a look at some scenarios of hypothetical savers that could provide you with novel IRA saving strategies.

Picking the right IRA for your retirement savings

401(k) accounts provide millions of Americans with a retirement savings account. Still, not everybody has a 401(k) — and even those who do have one should complement it with an individual retirement account (IRA).

Given you have a limited amount of income at your disposal to sock away for retirement, what kind of IRA would work best for you depends on your individual situation. Here’s a few scenarios for different kinds of savers, providing a combination of accounts that play to the strengths of their financial situations.

IRA retirement saving strategy: Entry-level office worker

What you need to do: You may have to endure endless status meetings and office birthday parties for coworkers you barely know, but at least you have a 401(k) with an employer match. You should set your contribution to maximize your employer’s 401(k) match and open a Roth IRA in order to tax advantage of your biggest asset: your potential future earnings. Check out our review of the best Roth IRA providers on the market to help you find the right broker for your retirement savings.

Why you need to do it: Employers who match your contributions to your 401(k) are essentially giving you free money. Even if you’re working for a modern day Mr. Scrooge who doesn’t give you a match, a regular 401(k) account still allows you to make contributions directly from your paycheck before any tax is applied, and those contributions will remain safe from the IRS until you begin taking your withdrawals decades later.

As an entry-level office worker, you’re probably not making a lot of money, and that likely puts you in a lower tax bracket. By the time you’re ready to take your withdrawals, you may discover the money you saved by avoiding taxes isn’t worth the bigger bite Uncle Sam takes now that you’re a member of the country club crowd.

To see this in action, take a look at the income tax brackets for tax year 2019. Even if we make a generous assumption regarding your salary as an entry level office worker and say you earn more than $39,475 (but less than $84,200) a year, you still would only be taxed 22% on this income. That means the money you contributed to your 401(k) was sheltered from this 22% tax, and you face tax payments when you withdraw it in retirement, decades later. If you were a retiree taking withdrawals this year and making, for example, more than $160,725 (but less than $204,100) you could be paying up to 32% on money you withdraw from a 401(k).

Contributions to a Roth IRA are not sheltered from taxes, meaning you pay taxes on all your income and then make your Roth contribution, while the interest earned in the Roth is tax-free. Because you’ve already paid income tax on Roth IRA contributions, you aren’t taxed again when you take your withdrawals from the account. Anyone who expects to find themselves in a higher tax bracket when they’re ready to retire should open a Roth IRA now, as you can reap extra tax benefits from your current status as a lowly office drone.

IRA retirement saving strategy: Self-employed freelance worker

What you need to do: Whether you’re making enough money from your Etsy shop to avoid the 9-to-5 office grind or you hop between projects as a freelancer, the freedom of self-employment comes with non-trivial costs. But you don’t have to sacrifice your retirement savings just because you don’t have a 401(k). On the contrary, you need to look into opening a Simplified Employee Pension (SEP) IRA and a Roth IRA. We’ve taken a close look at the best IRA providers on the market to help you choose the right provider, so go check out our round-up.

Why you need to do it: A SEP IRA is a retirement account that’s easy to set up and has low, or often zero administrative fees, which are big advantages for the busy freelancer. It also allows you to contribute up to 25% of the gross annual salary you make from the business (which as a self-employed freelancer usually works out to about 20% of your adjusted net income), up to a limit of $56,000 in 2019. That far outstrips the $6,000 contribution limit on traditional and Roth IRAs for those under 50 years of age, making it a powerful saving tool for your retirement.

However there’s no Roth version of a SEP IRA, meaning all of the contributions you make to it will be taxed when you start making your withdrawals — at whatever tax bracket you happen to find yourself in. That’s why you may also want to open a Roth IRA so you have a source of money you can withdraw tax-free.

IRA retirement saving strategy: Bold market expert with money to burn

What you need to do: When it comes to saving for your retirement, we generally advocate for a slow and steady approach. However, if you don’t have confidence in traditional investment assets such as stocks and bonds but are brimming with self-assurance about your ability to judge non-traditional investments such as real estate, you can open a self-directed IRA.

Why you need to do it: Because you’re convinced you need more flexibility in your investments than a gold medal gymnast, you want a tax-advantaged account for your holdings in peacock farms, marshmallow factories, and yacht fleets. In short, you want to make sure you’ve diversified your investments to such a degree that even if the unthinkable happens and the market permanently implodes you’ll have a safe haven of funds.

If you go down this route, pay attention to the additional pitfalls that come with a self-directed IRA, such as the fact that you won’t have a team of financial experts vetting the quality of your investments and that you can inadvertently disqualify your IRA of its tax advantages if you gain a direct financial benefit from one of the IRAs investments (beyond the money it earns for your IRA).

The bottom line on IRAs

None of the three scenarios outlined above will likely fit your unique financial situation to a T, but it should prove a good starting point for you to think about how an IRA can work into your overall retirement savings strategy. Putting away any money at all is better than nothing, but when it comes to the savings that will fund your golden years, “better than nothing” may not be good enough. Make sure you’re doing everything you can to make sure your IRA is A-OK.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James Ellis
James Ellis |

James Ellis is a writer at MagnifyMoney. You can email James here

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Everything You Need to Know About 401(k) Matching

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You probably know that 401(k) accounts are how your employer helps you save for retirement, but did you know that many employers match your 401(k) contributions? Taking advantage of 401(k) matching is one of the best ways to boost your retirement savings. After all, it’s free money.

Unfortunately, most 20-somethings in America aren’t even meeting the $19,000 401(k) contribution limit for 2019, averaging only about $11,800 in contributions, according to a study from CNBC and Fidelity. Around 42% of Americans aged 18 to 29 don’t have any retirement savings to begin with, the study found.

If you find that you’re not meeting your contribution limits, read on to get a handle on how 401(k) matching works and why it’s something you should be taking full advantage of. We’ll explore some real-world situations and get some tips and tricks from experts. Be sure to also check out our complete guide to maximizing your 401(k).

How does 401(k) matching work?

For the uninitiated, 401(k) matching is when your employer makes contributions to your 401(k). Your employer puts money into your 401(k) along with you — “matching” your contribution — up to a certain amount, and with certain conditions.

There are two main employer approaches to 401(k) matching: partial matching and dollar-for-dollar matching. In addition, you need to be aware of 401(k) vesting.

Partial 401(k) matching

Partial 401(k) matching is a common employer strategy. Much like it sounds, this is when employers match a portion of an employee’s contribution, rather than matching it 100%.

For example, your company could choose to match 50% of your contributions up to 6% of your salary. So if you contribute 4% of your salary, they’ll contribute 2%. To maximize your employer’s policy, you’d have to contribute 12% of your salary to your 401(k) to get them to contribute their max 6%. Another partial match example may look like a 100% match for the first 3% and a 50% match on your contributions above 3%, up to 5% of your salary.

Dollar-for-dollar 401(k) matching

A dollar-for-dollar 401(k) match is when your employer elects to match 100% of your own contribution. So if you contribute 3%, they’ll also contribute 3%. However, there’s still usually a limit to how much they’ll match. Let’s say your employer match maxes out at 5%. To get as much out of their policy as you can, you’ll want to contribute 5%. If you contribute any more, any excess above 5% won’t be matched.

401(k) employer match vesting

When you’re checking out your employer’s match policy, look for any mention of vesting. If there is a vesting schedule, that means your employer’s contributions aren’t yours immediately. Instead, you have to wait anywhere between one and three years for the money to be yours.

For example, an employer could allow you access to 33% of your match contributions after you’ve been at the company for a year, another 66% after two years and then the full 100% after your three-year mark. Some companies might even make you wait for three years for 100% vesting. It’s important to check your company’s vesting schedule early on.

No matter what steps you take to maximize your employer’s 401(k) matching, it could go down the drain if you don’t double check that vesting schedule. Be proactive and always look for any vesting policies. If you don’t, you could end up losing your match.

Always ask about your employer’s 401(k) matching policies

Not all employers offer 401(k) matching. Even if they do, employers aren’t always upfront about what they match. That was certainly the case for Robin, a pollster in Washington D.C. “When I began working at a startup company, there was no employer-match program,” she said. “However, I later found out that a program had been put in place that I had not been aware of.”

Only after we reached out to Robin, who declined to give her last name for this article, about her experiences with 401(k) matching did she find out about her company’s new matching system. “This policy was not made clear to me when it was rolled out, and I’m unsure how it was communicated to existing employees,” she said.

Be sure to ask about your company’s 401(k) policies upfront. If Robin’s situation is any indication, it may also help to periodically check in on those policies, as they may have changed. It’s important to educate yourself on what 401(k) matching looks like and what to look out for.

Expert tips and tricks for 401(k) matching

Sometimes it takes an expert’s opinion to jolt you into action. You may already know that you should be contributing to your 401(k) and using that employer match. But take it from these financial experts, it’s pretty easy to change your behaviors and keep from missing out on such a big reward.

Do not assume you don’t make enough money to contribute to your 401(k)

“Many times, individuals overestimate the impact that setting a 401K deferral rate will have on their tax home pay,” says Edward P. Schmitzer, CPA/PFS, CFP® and President of RCA Wealth.

Schmitzer suggests running some numbers to see the actual impact a 401(k) contribution might have on your net take-home pay. You can even chat with your payroll manager to help you. That way, you can compare your current paychecks to what they could look like. “People are often surprised on how little their net goes down due to the tax savings of a deferral to the 401(k),” said Schmitzer.

Find out how often your employer 401(k) match is paid

“This is one of my best tips” said Liz Gillette CFP® at MainStreet Financial Planning, Inc. Many employers match on a paycheck-by-paycheck basis. So if their cap is set at 4%, that means they’ll only match up to a maximum of 4% of each paycheck.

“When an eager saver changes their contribution rate, and perhaps adds a larger than usual payment, they are often leaving money on the table,” she said.

For 2019, you’re allowed to contribute a maximum of $19,000 into your 401(k). If you set up your elections so that you meet that maximum before the end of the year, you’re missing out on employer match for the rest of the year’s paychecks.

Take this example from Robert J Falcon, CFP®, CPA/PFS, MBA at Falcon Wealth Managers, LLC. An employee making $190,000 sets up a 10% 401(k) contribution rate, hoping to defer the max of $19,000 for the year. Let’s say that employee gets a promotion and a 10% raise on January 1, but does not reset their contribution rate.

Since the company is matching max 4% per paycheck, in the new year, the employee will reach their $19,000 contribution max in November, missing out on a complete match that month, and they won’t receive any company match in December.

The employee could have maximized the employer match by reducing their contribution rate to 9%. That way, they would still come very close to the $19,000 contribution limit in December while also snagging the match throughout the full year as well.

What to do if you can’t afford your 401(k) employer match

Start by putting as much into the 401(k) as you can afford, regardless of getting a full match or just a partial match, suggests Schmitzer of RCA Wealth. With each raise you receive, increase the savings rate 1% to 3% at the same time that the raise takes effect.

According to Mark Wilson, APA, CFP® and President at MILE Wealth Management LLC, making 401(k) getting even a partial matching contribution is one of the few no-brainers of investing.

“Change your 401(k) contribution amount to 3% or 5% and commit to this for three months,” said Wilson. From his experience, few people ever notice the difference. “Most will be surprised at how easy it is to start accumulating. Free money and early compounding make a big difference.”

If you have a dual income household and share finances with your partner, you’ve got room to maneuver. Christopher R. Wells, CFP® and founder of Flourish Financial Planning, starts by figuring out which spouse’s plan has a better match. “I maximize that contribution,” said Wells.

For example, let’s say your company matches 25% of your contributions, but your spouse gets a 100% match. In that case, reduce contributions to your plan and maximize contributions to your spouse’s plan.

The 401(k) takeaway

No matter your situation, there are ways you can take advantage of your employer’s 401(k) matching. It’s an easy way to boost your retirement savings without much more effort on your part. Be sure to ask questions and clear up any confusion at the start. That way, you know just what kind of vesting schedule and limits there might be. Even if there is no match, you’ll know sooner, rather than later, that you’ll need to start up your retirement savings elsewhere.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Lauren Perez
Lauren Perez |

Lauren Perez is a writer at MagnifyMoney. You can email Lauren here

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The Big Cost to Your Retirement from Small Annual Fees

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

People like to think of retirement as the time when you get to enjoy a well-deserved rest, but let’s not forget that retirement is also a race between finances and life expectancy. In this high-stakes dash, small investment fees can snowball into budget-devouring amounts over the course of decades.

Take the seemingly insignificant fee charged by the companies that create and manage retirement funds, the so-called expense ratio. A new study from MagnifyMoney reveals how small differences in expense ratios can cost retirees tens of thousands of dollars over the lifetime of their investment, a warning millennials and anyone else who is starting their retirement journey should heed when choosing investments.

In a recent Fidelity survey, 74% of respondents underestimated how much they should save for retirement compared with what financial professionals suggest. This is just one more reason why paying attention to seemingly small fees is a big deal.

Tiny differences in fees have outsized impacts on your savings

To illustrate how much of your retirement savings can be consumed by seemingly small investment and brokerage fees, MagnifyMoney crunched the numbers on two different hypothetical fund investments. The amount invested and the rate of return on both funds was assumed to be the same — the only variable was the expense ratio, which reflects the different management fees for each fund.

In our exercise, one hypothetical fund charges a low annual fee of 0.02% of the total investment balance ($10,000 annual contribution over 25 years), while the other commands an annual fee of 0.99%. While the difference between the fees charged may appear insignificant, the gulf between earnings after 25 years was vast — the fund charging the 0.99% annual fee earned a total of $759,018, while the fund with the 0.02% fee earned $891,142. That’s a difference of $132,124, or approximately 17% of the total earnings on the high-fee fund.

How compounding expenses eat into your returns

Why the yawning disparity between the two earnings totals after 25 years? You might expect the difference in earnings to mirror the gap in the expense ratios, which is 97 basis points.

The answer lies with compounding expenses and opportunity cost. Let’s say you invest $10,000 into a mutual fund with an annual return of 9.0% and an annual expense ratio of 0.99%. After the first year, your investment would generate a return of $900 (0.09 x 10,000 = 900). You now have $10,900, but remember you have to pay the expense ratio. In this case, you have to subtract $107.91 from your $10,900 (.0099 x 10,900 = 107.91) which leaves you with $10,792.09 invested in the fund.

If you leave that money untouched for another year, it would generate a return of $971.29 (0.09 x 10,792.09 = 971.29) and give you a total of $11,763.38. Subtract your 0.99% expense ratio and that leaves you with $11,646.92.

Now imagine you had invested that $10,000 in a different fund that also has a 9.0% annual return but no expense ratio. You still have $10,900 at the end of the first year, but this time you don’t have to take out the 0.99% to pay the fund’s expenses. That means your second year, you are earning a 9.0% return on $10,900 (as opposed to $10,792.09), which gives you $11,881.

Note the difference in earnings between the two funds. It’s not huge after just two years, but the compounding effect over a 25-year period explains the difference in the two hypothetical situations outlined in the section above. Compounding expenses are the reverse of the compound interest effect, by which reinvesting the earnings from savings earns you more and more money reinvesting the earnings from savings earns you more and more money. A compounding fee takes a bigger and bigger bite out of your investment over time.

Real world examples: funds tracking the S&P 500

The impact that even a slight difference in a fund’s expense ratio can have on retirement savings isn’t limited to hypotheticals. MagnifyMoney’s study also looked at what would happen if a saver invested $10,000 every year for almost 25 years, from 1994 until 2018, in two of the most popular index-based funds, the Vanguard S&P 500 Index fund (VFINX) and the SPDR S&P 500 exchange traded fund (SPY). For simplicity’s sake, the chart below shows the final four years of our hypothetical investment.

Looking at the historical data, investors in the Vanguard index fund would have approximately $784,300 by the end of 2018, while investors in the SPDR ETF would have about $785,100. If you bought the S&P 500 index (a very challenging proposition for a retail investor, which is why funds like the VFINX and SPY exist in the first place), that same investor would net roughly $798,300, indicating the low expense ratio of the VFINX and SPY funds would only cost investors around $13,000 after 25 years.

Keep in mind, expense ratios have been falling over time. The Investment Company Institute (ICI), an association of investment professionals, recently released a report showing the average expense ratio has declined from 0.99% in 1997 to 0.55% today. That doesn’t mean you can’t find yourself in trouble if you don’t pay attention to a fund’s expense ratio, but it does indicate these costs are shrinking as time marches on.

Should you always avoid funds with high expense ratios?

Your investment strategy needs to reflect your individual goals and willingness to accept risk, but is there any reason to place your hard-earned money in a fund with a high expense ratio?

“In general, you should pick the lower-fee product if you are comparing two investment products that will give you similar asset exposure,” said Josh Rowe, LendingTree’s manager of investments (MagnifyMoney is owned by LendingTree). “The higher the expense ratio, the more ground a mutual fund manager will need to make up to obtain the same return versus a fund with lower expenses, which means that the mutual fund manager will also have to take on additional risk.”

If you’re working with a personal financial advisor, it’s simply a matter of making clear to them that finding funds with low expense ratios are a priority. However, if you are investing on your own, Rowe has some advice on how to find funds with lower expense ratios.

Take a look at the ETFs robo-advisors use by finding that list on the company’s website. “Many robo-advisors actually provide a detailed list of the ETFs that they invest in, often in the ‘White Paper’ section of their website explaining how the robo-advisor works,” said Rowe.

Examine the expense ratios of those funds and, if they’re low enough to your liking, you can buy the ETFs yourself through a self-directed broker and avoid the robo-advisor fee, which is often around 0.25% of your invested balance annually — and robo-advisors charge this fee in addition to an expense ratio. You can also do the same with larger brokers, many of which have lists and screening tools that allow you to only look at low expense ratio funds.

While the importance of a fund’s expense ratio shouldn’t be underestimated, you also need to keep in mind it doesn’t represent the totality of fees you pay for that fund. For example, if you are investing in a fund through a 401(k) or a similar type of employer-sponsored retirement plan, there’s a separate fee negotiated between the employer and the plan providers (the company that actually manages the investments constituting the retirement plan).

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James Ellis
James Ellis |

James Ellis is a writer at MagnifyMoney. You can email James here