The Three Savings Accounts You Need Part Two: Retirement Savings

retirement saving reward

Last week we talked about the first type of savings account you need, the emergency savings account. This week, we’re going to take things up a notch and talk about the most adult, serious type of saving you can do: retirement savings.   

What is a retirement savings account?

As you no doubt know, saving for retirement is basically what you spend 100% of your pre-retirement life doing, which is a little depressing if you really think about it. But seriously, saving for retirement is the unglamorous, trudging work of the money-savvy lady. If you’re under 60, retirement seems like a distant, shimmering mirage—it’s hard to even imagine that one day you’re going to want to slow down and live off the saved fruits of your labors. But you are—barring an unforeseen zombie plague, of course.

How you set about saving for your retirement is a fairly massive topic, but for our purposes here, we’ll hit on the basics. In terms of your savings goals, you see a lot of hysterical articles saying you need at least $1 million or more to retire. To be honest, you probably need less than that to cover your day-to-day retirement expenses, excluding healthcare and long-term care. The funding of healthcare expenses is a big topic, so, for now let’s say that you should shoot for saving as much as you can for retirement, and we’ll talk specifics later.

How do I do it? (That’s potentially also what she said)

First, you’re going to want to use some type of tax-advantaged savings vehicle to do the saving. If you’re American and employed by a company, you may have access to a 401(k) or 403(b) plan, or even more miraculously, a pension plan. If you do, that’s the very ticket, and you should start piling money in post-haste. If you’re a roaming freelancer or don’t otherwise have access to an employer-sponsored plan, you’re going to want to look into an individual retirement account or IRA.

Second, you’re going to have to determine your contribution. If you’re working with a 401(k), you can contribute up to $18,000 a year tax-free. If you’re using an IRA, the figure is $5,500. What that means is that the money you pay into your 401(k) is deducted from your salary, and you only pay taxes on the remainder—it’s a way for the government to encourage you to save for your golden years by reducing your tax bill today.

Now, you may be wondering how you should do this—do you finish filling up your emergency savings account first, then pile into retirement saving? Or do you do the two at the same time?

As a general rule, the earlier you start saving for retirement the better, because of the Power of Compound Interest (I am obliged to write it like that because of how much people love it). In addition, plenty of companies offer some type of retirement savings matching that is a great incentive to start ASAP. For example, your employer may match your contributions to your 401(k) up to 5%. In that case, you’d be crazy not to be putting away the 5% and getting some sweet free money from your company. So, here’s what I would advise (assuming you’re living the “save 25% of your income” life):

  1. Immediately sign up to contribute to your 401(k) to maximize matching. Let’s say it’s the 5% situation outlined above. That means you’ll be saving 5% of your income in your retirement account, with a lovely bonus 5% from your employer.
  2. Save the other 20% that you’ve committed to saving in your emergency fund until you’ve hit the magic 6 months of expenses.
  3. Then you can switch the rest of your savings into either your retirement account or a targeted savings account (which we’ll discuss next week).

Technically, this plan will result in you saving more than 25% of your take home pay, because you’ll be getting some bonus savings from your company matching and the first 5% you save is of your gross income, not your net income. But if you operate on the principle of “If you never have it, you won’t miss it”, this is a nice, sneaky way to push up your savings rate and start building the base of a solid financial future.