You know the hardest part of exercising? Going to the gym. Once you’re there, it’s great. But getting there is hard.
The same applies to saving for retirement. It’s easier when you have a full-time job and can earn benefits. But if you’re self-employed, you’re overwhelmed by choices. What’s the best plan for me: Traditional IRA, Roth IRA, SIMPLE IRA, SEP IRA? Once I pick a plan what should I put in it: bonds, stocks, mutual funds? Which bonds, stocks, mutual funds? How many of each?
The questions keep coming until you just stop thinking about it. That is, you stop until the next time you find yourself awake at 1:00 in the morning worrying if you could live on Social Security alone.
Here are four easy steps to starting a retirement account. You can complete them all in less than an hour. Is this the perfect plan for your specific situation? Maybe not, but if you haven’t done anything yet, at least it will start you in the right direction — which is better than no direction at all.
Which Plan?
Start with a basic Individual Retirement Arrangements (IRA). IRAs come in two flavors: Traditional and Roth. Both are similar in that money inside the plan is not taxed — that is, you pay no income tax on your investment earnings (interest, dividends and capital gains). This leaves more money inside the plan to grow (a tremendous long-term advantage).
The difference between the plans is how money goes in and comes out. Contributions to a Traditional IRA are tax-free. If you put $5,000 into the plan, you get a $5,000 deduction on your tax return. In retirement, any money taken out of a Traditional IRA (your original contributions plus all earnings) is taxed as regular income.
You don’t get a tax deduction for Roth IRA contributions, but everything taken out for retirement is entirely tax-free. Traditional IRAs are best for people in higher tax brackets (28 percent and above). Other people may want to consider a Roth.
Where?
Keep your IRA at a mutual fund brokerage. I personally prefer Vanguard, but Fidelity is also a reasonable option. Visit their website and you can set up an IRA online. If you have questions, give them a call.
Which Investment?
This stumps everyone because the choices overwhelm: There are literally tens of thousands of options among stocks, bonds and mutual funds. Again, let’s make it easy: Pick a Target-Date mutual fund.
Your IRA needs a combination of stocks (long-term growth but short-term price volatility) and bonds (low-growth but more price stability). You make money with stocks; you keep money with bonds. If retirement is a long way off, you want more stocks than bonds because you need growth and have the time to weather market downturns. As you near retirement, you want more bonds because you have less time to ride out market downturns and you need the safety (price stability ) of bonds.
A Target-Date fund makes these adjustments for you. Pick a target fund whose date is closest to when you will retire. If you plan to retire in 20 years, you would pick the fund dated close to 2036. For Vanguard, this would be the Target Retirement 2035 fund. For Fidelity, it is the Fidelity Freedom 2035 fund. Each of these mutual funds begins by holding lots of stocks (for growth) and a few bonds. As it gets closer to the target date, stocks are sold and replaced with bonds so the fund is sheltered from stock market fluctuations.
How Much?
You can contribute a limited amount of money annually to an IRA. Currently, the annual limit is $5,500 ($6,500 if you are more than 50 years of age). To ensure your IRA actually gets funded, set up an automatic monthly contribution. Figure out how much you need to contribute each month to reach your limit (or how much you think you can afford). Then set up an automatic monthly contribution by instructing your bank to send money directly to your IRA. You can also do the same thing from the fund side.