Your mom and dad probably told you as a young adult to be aware of what kind of decisions you make, as they could haunt you the rest of your life. There is some truth to that bit of parental wisdom, especially when you are saving for retirement. The decisions you make during your working years could affect your golden years. Here are some questions to consider when planning for your retirement future:
When should I start saving? This one is kind of a no-brainer. The earlier you save, the better position you will be in financially when you hit retirement age. If you started saving $5k a year in a 401k at age 25, with a 6% annual return on investments, your little nest egg would be a comfy $798,741 at age 65. In contrast, if you waited until 40 to start saving $5k a year with the same return rate, you would only yield around $283,161. And saving more than $5k a year won’t make up for lost time, either. If you started saving $10k a year at 40 years old, you still would only get $566,315. But, now is better than never.
Employer 401k matching: This one should be a no-brainer as well. If your employer offers to match money you save in your 401k, then DO IT. It’s like passing up free money if you don’t participate. A common match might be 50 percent of the first 6 percent of pay you save. Under that scenario, someone whose annual salary is $35,000 and who contributes 6 percent to the plan ($2,100) would receive an additional $1,050 in matching employer contributions. You’d be hard-pressed to find a 50 percent return on any investment. Even if your employer doesn’t offer matching contributions, the tax advantages of a 401k are beneficial by themselves.
What happens if I cash out my 401k early? We all have things that come up unexpectedly. Life is funny that way. Cashing out your 401k seems like to be a quick fix to an expensive problem, but it can lead to a significantly smaller retirement nest egg and there are expensive tax consequences involved that could make your nest egg even smaller when it’s all said and done. Hewitt Associates study of large-company 401(k) plans indicates that 45% of employees cash out their 401(k) plans when they change jobs. If you cash out your entire 401k, you must pay federal income tax on your entire withdrawal. In addition, you may also owe state tax on your distribution. Not only that, but the IRS will consider your payout an early distribution, meaning you could owe a 10% early withdrawal penalty on top of combined federal, state, and local taxes. You may be better off borrowing from your 401(k) than cashing it out. Depending on your plan’s terms, you may be able to borrow at a lower rate from your account than you could from a bank or other lender, especially if you have a low credit score.
When should I collect Social Security? Full retirement age is 66 for baby boomers and 67 for those born after 1960. If you take Social Security earlier like 62, you won’t get the full amount of benefit and will get payments that are 30% smaller than if you had waited until 67. It’s better to make your Social Security payment as big as possible and try to delay claiming until age 70, if you can.