When you’re young, retirement may seem too far off to worry about. But what’s critical to understand is that you can get away with saving less money and still end up with a much bigger nest egg if you start investing sooner rather than later.
Putting time on your side gives you a huge leg up due to the power of compounding, which happens when the growth in an account gets continually reinvested. The longer your earnings continue to make more earnings, the more wealth you’ll accumulate.
Even if you’re late to the investing party and haven’t already heeded this advice, it’s never too late to get on a better financial path. Investing consistently is a simple, but extremely powerful way to grow your retirement savings at any age.
If you have concerns or unanswered questions about investing for retirement that have kept you from getting started, it’s time to get more clarity. That can make the difference between moving your finances forward with confidence or staying stuck and never building wealth.
In this post, I’ll answer 3 questions that I recently received about retirement. You’ll learn how to choose the best accounts, cut investment fees, and manage risk the best ways possible.
Free Resource: Retirement Account Comparison Chart (PDF download) - get this handy, one-page resource to understand the different types of retirement accounts.
3 Questions & Answers About Retirement
Here are some great questions from Money Girl readers, podcast listeners, and members of Laura's free Dominate Your Dollars Facebook group:
Retirement Question #1
Michelle M. says, “My husband and I are 29-year-old newlywed professionals with generous combined income and hopes for an early retirement. I’ve heard you suggest maxing out your 401k before contributing to an IRA. But we have only been contributing enough to max out the match from our employers and then maxing out our IRAs. That’s because I’ve read that 401k fees are generally higher than IRA’s. How do you evaluate fees when choosing the right retirement account?”
Answer:
Thanks for this great question, Michelle. Investment fees are an important consideration because they can slowly eat away at your nest egg over time.
While there’s no free lunch when it comes to investing, there are some easy ways to lower fees. There are three different kinds to be aware of: administration fees, service fees, and investment fees.
While there’s no free lunch when it comes to investing, there are some easy ways to lower fees.
Administration and service fees of a 401k or an IRA are largely out of your control. They may be included in the investment fees or charged to your account separately. They cover the many costs of maintaining your retirement plan, such as fund management, service representatives, websites, accounting, and tax reporting.
Service fees are one-time charges associated with using certain features of a retirement account, such as making a hardship withdrawal, taking a 401k loan, or doing an IRA rollover. These pay for the personnel, paperwork, and reporting required.
Investment fees are the largest, but are also within your control, to some extent. These pay to have your money managed in any fund you choose and are known as an investment’s expense ratio or ER. Investment fees are not unique to 401ks or 403bs offered by employers; they’re also charged on investments in IRAs and taxable brokerage accounts.
You simply can’t avoid investment fees; however, you can choose funds with low expense ratios because they’re clearly listed on any investment menu. Even one percentage point can really add up when you do the math.
Let’s say you invest $10,000 a year for 40 years in 401k. Getting an average net return of 6% instead of 7%, means you’ll have $1.5 million to spend in retirement instead of $2 million. Paying just 1% in fees over four decades would cost about $500,000.
If you want to own stocks and see two similar growth mutual funds on a 401k or IRA menu, look at their expense ratios. If one charges 1.25% and the other charges 0.25%, I’d choose to invest in the cheaper fund. Ideally, you’ll have several options with expense ratios lower than 1% and if you can go lower than 0.5%, even better.
There’s no truth that investment options in a 401k are always more expensive than those in an IRA. It just depends on the investment firm and the types of funds offered. You’ll find that index funds are some of the least expensive because they’re passively managed.
There’s no truth that investment options in a 401k are always more expensive than those in an IRA. It just depends on the investment firm and the types of funds offered.
In some cases, additional administrative fees of a workplace retirement plan can be more than offset by having access to institutional funds with extremely low expense ratios. I’d prefer you max out a 401k with low-cost funds than to invest less in an IRA. For 2017, you can contribute up to $18,000 (or $24,000 if you’re 50 or older) in a workplace plan, but only $5,500 or $6,500 in an IRA.
So, my advice is to first max out your 401k or 403b because they offer so many benefits such as company matching, a high annual contribution limit, a Roth option with no income threshold, and automatic payroll deductions. Give workplace retirement plan fees healthy consideration in how you select investments, but don’t let them keep you away from leveraging these great accounts.
If you really don’t like your investment choices, let your employer know that you’re interested in having different options. And if you really feel strongly that your 401k choices are far inferior to those in an IRA, I’d say that maxing out an IRA is better than not investing at all.
See also: Should You Invest in a 401k With No Matching?
Retirement Question #2
Michelle M. says, “My husband has a health savings account from a previous job, but with his current employer he no longer has a high-deductible health plan. While he can still use the money for health expenses, he’s getting slammed with a $5 per money maintenance fee. Is there a way to roll over his plan into an account with no fees?”
Answer:
I’m a huge fan of health savings accounts or HSAs because they allow you to pay for or reimburse yourself for the cost of qualified medical expenses on a pre-tax basis. Technically they’re not a retirement account, but they resemble a traditional IRA if you reach age 65 and still have a balance in the account.
Using an HSA dramatically cuts the cost of out-of-pocket health expenses before you meet your deductible or that may not be covered by health insurance, such dental care, eye exams, eyeglasses. You can even use tax-exempt HSA funds to pay for services like chiropractic care, weight loss programs, and acupuncture.
As Michelle mentioned, to qualify to contribute to an HSA, you must first be enrolled in a high-deductible health plan. These health policies come with higher deductibles and lower premiums than traditional plans.
You can get high-deductible coverage on your own or through group benefits, if your company offers it. In addition, some employers may recommend that you open an HSA at a specific financial institution. However, there’s no rule that you must use it.
You can get high-deductible coverage on your own or through group benefits, if your company offers it. In addition, some employers may recommend that you open an HSA at a specific financial institution. However, there’s no rule that you must use it. One of the major benefits of an HSA is that you own it, not your employer.
Most HSAs charge a monthly service fee because they do require more maintenance than a typical bank savings account. But some HSAs waive fees after your average account balance exceeds a certain amount, such as $1,000. If you keep a high balance, you may also want an account with investment options, such as mutual funds, to help your funds grow even faster.
Like Michelle’s husband, you may get special HSA perks only while you’re employed with certain companies. But don’t worry, it’s easy to transfer funds to a new account. Once your new HSA is open, contact the institution with your existing account and request a rollover form to transfer funds, without triggering any taxes or penalties, and close the account.
But if for some reason, you can’t find a new HSA that waives all fees, I’d argue that paying a few dollars a month or $60 per year is more than offset by the huge tax savings the account gives you. For instance, let’s say you pay an average tax rate of 20%. Just using HSA funds to pay for one pair of eyeglasses or prescription sunglasses that cost $300 would save you $60 in taxes.
I’m not saying that I like paying monthly or annual fees on any type of account. But in some cases, the benefits and savings you get make paying a small fee worthwhile. So, it’s better to have a tax-free HSA and pay reasonable fees than to not have it.
Another benefit of an HSA is that even if you become unqualified for it while you still have money in the account, it’s not a problem. There are no taxes or penalties on an HSA if you become unemployed, uninsured, or change jobs and are no longer covered by a high-deductible plan.
You can still spend the funds or use them to reimburse yourself for qualified medical expenses until you empty the account. The only restriction is that you can’t make new contributions to an HSA when you’re not enrolled in a qualified high-deductible health plan.
In other words, you can continue to manage the funds and spend them on qualified expenses, but you’re not allowed to add new funds to the account.
See also: Healthcare Q&A: Reform, Rules, and the Role of HSAs
Retirement Question #3
Linda H. says, “I’m 23 years old and just started a Roth IRA. I’m also planning on starting a 401k through work in the future. But I’d hate to save money for years only to have it be stolen or disappear in another market crash. What are the risks of using these types of accounts?”
Answer:
Linda, thanks for this question and congratulations on starting to invest for retirement at such a young age! If you make a commitment to invest $5,000 a year for the next 45 years, you could easily have $1.5 million to spend in retirement.
One of the most uncomfortable aspects of investing is that it does involve risk. We all want to make money, but no one likes the idea of potentially losing some or all of it.
One of the most uncomfortable aspects of investing is that it does involve risk. We all want to make money, but no one likes the idea of potentially losing some or all of it.
There’s no guarantee that we won’t have another market crash. I know that may be upsetting to hear. But history shows that the U.S. markets have recovered from big declines and still provided investors with long-term gains.
According to Fidelity, over the past 35 years, the market has experienced an average drop of 14% from high to low during each year, but still has a positive annual return more than 80% of the time.
It’s important to remember that temporary drops in the market don’t matter unless you need to cash out your investments and take a loss. If you have decades to go before you’ll need to spend your investments, expect to see many short-term ups and downs.
Having a diversified portfolio or group of investments that are spread out over different asset classes and categories helps you avoid losses. You can choose funds that have baked-in diversification, such as index funds and target date funds, which are made up of hundreds or thousands of individual investments and reduce investment risk.
See also: Investing Tips for College Students and Baby Boomers (Plus Everyone in Between)
For other types of risk, such as funds being stolen or an investment firm going out of business, there is an agency that helps keep you safe. The Securities Investor Protection Corporation or SIPC is a nonprofit corporation that was created by Congress in 1970 to cover the losses of investors, within certain limits.
The SIPC works to return your missing cash, stocks, funds, or other securities when your brokerage goes out of business and still owes you money. If they can’t satisfy all investor claims for missing money, they have reserve fund that can be used to make up the difference, up to certain limits.
The reserve is funded by member brokers. It can be used to supplement each investor’s losses for up to $500,000, which includes a maximum of $250,000 for cash claims. Remember that the SIPC doesn’t bail you out from bad investments or even heeding bad advice, but is a backstop if your money is stolen or your investing firm goes belly up. You can learn more at sipc.org.
One of the benefits of using a retirement account, such as an IRA or a 401k, to own investments, is that they give you huge tax breaks, which save money. But another benefit is an added layer of legal protection.
One of the benefits of using a retirement account, such as an IRA or a 401k, to own investments, is that they give you huge tax breaks, which save money. But another benefit is an added layer of legal protection.
Workplace plans, such as a 401k or 403b, are covered by a federal law called the Employee Retirement Income Security Act (ERISA). It sets minimum standards for those who manage and control plan assets and gives certain protections to employees who participate in them.
That means there’s easy recourse if you participate in a 401k at work and your employer goes bankrupt or disappears with your plan’s money. These plans are managed by third party administrators, so it would be difficult for any theft to occur in the first place. The same is true for IRAs, but they’re covered instead by state laws.
So, I would not worry about investments in a retirement plan or a well-known brokerage getting hacked or stolen. Stay focused on investing a minimum of 10% to 15% of your gross income no matter what.
Depending on how and when you measure market returns, the numbers prove that our economy grows and corporations thrive. During the 20th century the stock market return averaged over 10%. Being disciplined with regular contributions doesn’t guarantee that you’ll see investment gains every year—but over many years you will.
See also: How Much Money Do You Need to Retire?
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