Finance

4 Retirement Tools You Should Be Using

If you are like most Americans, you probably feel that your retirement savings are pretty weak. You may not even realize how far behind you are on saving. In this article, we show you four incredible tools you can use to start kicking butt at your retirement saving!

January 10, 2022

4 Retirement Tools You Should Be Using

If you are like most Americans, you probably feel that your retirement savings are pretty weak.

You may not even realize how far behind you are on saving.

Fear not!

I am going to show you four incredible tools you can use to start kicking butt at your retirement saving!

But first, a little background into retirement savings and why these tools work.

When Should You Start Saving For Retirement?

Simple. NOW!

You may think now is not a good time. You may believe you can’t spare any money for retirement. You may feel that you are too young to worry about retirement. I know there are often expenses that take precedence over retirement. I know that it’s hard to make retirement a priority when it’s ten, twenty, thirty, or even forty plus years away.

However, when building wealth or planning for retirement, time is your ally.

Why Is Time Your Ally In Saving For Retirement?

Because of COMPOUNDING INTEREST.

Compounding interest is when you make interest on your money; then your interest makes interest.

For example, say you invested $100 in stock. You made a 10% return. Now you have $110. If the next your you make another 10% you make 11 dollars (10% of 110) instead of the $10 you made before. This amount may not seem like a lot, but compounding interest is EXPONENTIAL – over time your money grows faster and faster.

The more time you give your money to compound = the wealthier you will be, and therefore the more prepared for retirement. When you combine time and compounding interest, you don’t have to save as much money out of your pocket. As you can see, a lesser amount of savings can go a lot further the earlier you start.

So, how much should you be saving?
  • In your 20s, try to set aside 10%–15% of your income for retirement.
  • In your 30s, try to set aside 15%–25%.\

If you delay saving, you will need to dedicate a higher percent of your money to retirement.

Okay, now you know how much you should be saving and you should start pronto, let's move on to four incredible tools you can use to start kicking butt at your retirement saving!

4 Tools You Can Use To Save For Retirement:

1. Traditional 401K Retirement Plan

What is a 401K?

A 401K is a type of retirement plan that is sponsored by a business for the employees of that business. Not every business has a 401K. If your company offers a 401K – use it!

There are several neat benefits to a 401K:

  • Deferred taxation
  • Automated savings
  • Protection from creditors
What’s Deferred Taxation?

I’ll break it down for you. If you participate in a 401K program, your money comes out of your paycheck automatically. Your money is placed in the 401K each paycheck (at a percentage rate that you choose). The money that you are contributing comes out before you pay taxes. When you contribute before taxes, you lower your current paycheck (meaning you pay less income tax). Once that money is in your 401K it grows tax-free. All your gains, dividends, and interest each year are tax-free.

In retirement, you can use your 401K money to fund your life. And when you take the money out of your 401K that’s when you pay income tax. You may be confused now. Yes, you will still need to pay taxes.

But, you got to “kick the can down the road” which has two benefits:

  • Tax-Free Compounding
  • A potentially lower tax rate in retirement

Tax-free compounding means you get to use compounding interest to its full potential. Your money compounds at a faster rate without having to pay taxes each year. As an example, say, your money is getting 10% growth each year. Well in 401K you’ll get that full 10%. In a taxable account that could get dropped almost as low as 6% based on your tax rate.

The difference between the two can add up over time. The extra amount that gets compounded each year in a 401K can add hundreds of thousands or millions of dollars to your wealth over the course of a career. And once your money grows, you may get to use that money at a lower tax rate. In retirement, you have more control over when you have to receive that income because you may have multiple sources to fund your retirement. You also won’t be making or needing the same “salary” in retirement.

You can have flexibility in how much you pay in tax each year – pretty awesome!

Automated Savings

With a 401K you designate how much money that you want coming out of your paycheck. That money gets deducted AUTOMATICALLY. You don’t touch it – the money just goes into savings. What’s great about that is you mentally adjust your spending to what you actually see getting deposited into your bank account. If that same money hits your bank account, then you have to move it into savings manually – it’s a lot more painful!

The best part – You can put $18,500 ($24,500 if you’re over 50) away each year to grow on autopilot!

How neat is that?

Protection From Creditor

Protection from creditors is hopefully an aspect of 401K’s you’ll never need to use. But 401K’s can protect your money from creditors if you ever hit hard times. It keeps you protected from having your money seized during a bankruptcy proceeding. Again, I hope this is something you never have to experience, but it is an excellent aspect of a 401K. If you were to save that same money in a bank or investment account, it wouldn’t get protected. You worked hard for that money, and you deserve to keep it.

All in all, a 401K is a great tool to use to save for retirement. You get to save money for retirement AND pay fewer taxes. It’s a WIN-WIN

2. Roth 401K

Does your company offer a Roth 401k in addition to or instead of a traditional 401K? EVEN BETTER! I believe a Roth 401K is one of the best tools to save for retirement! The main difference between a Roth versus a regular 401k is how it gets taxed. As I showed above, when you put money into a traditional 401K, it comes out BEFORE you take out the tax. So, it lowers you the amount of income you are getting taxed on.

A Roth 401K doesn’t do that. A Roth 401K doesn’t give you a tax deduction when you put money into it. You may be thinking, “okay Josh, you just said this was one of the best tools for retirement, but it does not sound like it.”

Well, bear with me.

You don’t save on taxes RIGHT NOW with the Roth 401K, but over your working career, you save a BOATLOAD. Why? Because once you pay the tax (this happens automatically in your paycheck) and put the money into your Roth 401K, then you don’t have to pay taxes on that money again. That money grows tax-free, and You can use that money in retirement without having to pay taxes on it. The Roth’s tax treatment can REALLY save you on taxes over the life of your career. It also gives you a lot of flexibility with your other retirement income.

How?

For example, say you have a traditional 401K and a Roth 401K. In retirement, you pay tax on just the traditional. If you need a $100,000 salary, then you could take $50,000 out of the Roth and $50,000 out of the traditional 401K. For tax purposes, it seems as if you only used $50,000. See how that works?

You can contribute $18,500 to a Roth 401K each year ($24,500 if you’re older than 50). A Roth 401K ALSO enjoys the benefits of Automation and protection from creditors as well! If available to you, the Roth 401K is a powerful option for you to explore!

3. Traditional Individual Retirement Account (IRA)

So, what if your company doesn’t offer a 401k? Invest in an Individual Retirement Account (IRA).

A Traditional IRA works similarly to a 401K. One big difference is the money does not deduct from your paycheck automatically. You would need to open your own personal IRA at a brokerage institution (Charles Schwab, Fidelity, TD Ameritrade…etc.). You can put up to $5,500 ($6,500 if over 50). In an IRA each year. This $5,500 can be a tax deduction as well! And like the 401K it grows tax-deferred.

The money you put into the IRA can lower your taxable income this year. Then it grows and compounds tax-free during your working career. In retirement, you pay taxes on the money you take out of the IRA, but hopefully at a lower rate than your working career. As you saw earlier, the compounded tax savings over your career can have a huge impact on your livelihood in retirement.

IRA’s don’t provide the same level of automation that a 401K does, but it can be automated. Most institutions allow you to set up automatic transfers for each paycheck. The money hits your account, then transfers to an IRA on a designated day. Not quite as automated as a 401K, but it works! Another great feature of an IRA is that you can use it in addition to a 401K. You can use an IRA with a 401K allowing you to save $18,500 +$5,500 = $24,000.

As you can see, the IRA is a pretty cool tool that you can use to save for retirement.

Now last, but definitely not least…

4. Roth Individual Retirement Account (IRA)

A Roth IRA is a powerful tool that you can use if match these contribution limits.

So, what’s a Roth IRA? A Roth IRA is like the Roth 401K.

You can put money into a Roth IRA each year (up to $5,500 per year). The money that you put into the Roth, though, is after-tax money (you’ve already paid the tax). A Roth IRA doesn’t give you a tax deduction. If there’s no tax deduction, what’s the benefit? You don’t get a tax deduction; the money grows free from taxation. It’s also yours to use for retirement tax-free! Can you see how powerful that can be?!

If you don’t have to pay taxes on funds taken out of a Roth IRA in retirement, then you can have precise control over your tax bill in retirement – Pretty cool!

Before you jump into any of these retirement accounts, there are some things you should consider.

  • You have to keep the fund in a retirement account until a specific retirement age: If you don’t, you lose out on the cool features of these retirement accounts (and you can even suffer a penalty). For example, an IRA you need to keep the money in the IRA until you are 59 ½. If you take the money out sooner, you get a 10% penalty (and it counts as income for taxes) – not fun! Make sure you know the retirement age for your accounts.
  • 401K’s have been known to have high, hidden fees. Make sure you are aware of the fees you are paying.
  • You may not be allowed to contribute if you don’t have earned income. For example, IRA’s don’t allow you to contribute if all of your income is “unearned income”. Unearned income can be rental property rents, dividends, annuity payments…etc.
  • You can mix and match the retirement account types that you use (but you cannot exceed the total contribution limits as a whole). You can do $3,000 to a Roth and $2,500 to a Traditional IRA, but not $5,500 to both.

Final Thoughts

Any of these options can be a great fit. Make sure you take the time to evaluate which makes the most sense for you.

Once you know where you want to save, get out there and start doing it! NOW is the best time to start saving for retirement.

Your Money. Your Life.

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