Yes, I know. You probably keep hearing how important it is to start saving for retirement. Even with this advice constantly being thrown at people, many are not taking action. According to CNBC, 21% of people have nothing saved for retirement, with an additional 10% having less than $4,000 saved.
These numbers are rather scary, considering how much is required to retire comfortably. So few people are planning for retirement because they do not know where to start. Without knowing where to even begin, many are discouraged to take action at all.
With a basic explanation, it becomes clear that retirement planning is much simpler than it seems. In another article, I go over all aspects of retirement planning in great detail. You can read that article here.
However, if you want to learn more about the best places to put your retirement savings, then this article is for you. Let’s go over the three best ways for anyone to start planning for retirement today!
Take Advantage of Tax Benefits With a Roth IRA
A Roth IRA is probably the best investment vehicle for retirement planning. All contributions made to the IRA are post-tax. This means that all gains made within the Roth IRA are TAX-FREE.
Let me state that again for emphasis: All gains made within the Roth IRA are TAX-FREE.
Not investing this money in a Roth IRA would lead to various taxes. If you sell shares of stock for a profit, you have to pay capital gains tax on the gain. If you receive dividends from your stocks, you have to pay income tax on what you receive.
With the Roth, however, none of that is taxable. You can receive your dividend income and realize gains without the government taking their piece.
There are also unlimited investment options with this plan, and all investments are self-directed. You would have complete say in where you want to invest your money. So, you would be able to invest in individual stocks, like Starbucks, Apple, and Tesla, index funds, bonds, and so on.
When you are younger, you will have a lower income, thus be in a lower tax bracket. This means that your investments would be taxed at a lower rate now and not be taxed at all later when you withdraw.
What About a Traditional IRA?
Traditional IRAs can be ideal for the right person. The tax benefits they provide are the opposite of what a Roth IRA offers.
With a traditional IRA, all contributions made are deductible on your tax return. In other words, this means that the contributions are tax-free, not the gains. This could be beneficial if you are in a high-income bracket currently and plan on being in a lower bracket when retiring.
Although this may benefit some individuals, overall, the Roth IRA is the superior option. Having non-taxable gains is a complete game-changer for your retirement savings. Without this tax advantage, you could possibly have to pay the government over 15% on all profit made. Having to pay this tax can definitely derail your plan towards retirement.
Also, it is hard to predict in which tax bracket you will be in the future, which makes using the Traditional somewhat riskier. The odds are in favor of most people finishing their career in a higher tax bracket, which would make the Traditional pointless.
So, what are the drawbacks? As with everything, nothing is perfect. For one, an individual has to be 59½ before they can start withdrawing their gains. If done beforehand, there is a 10% penalty, in addition to the tax on the gain. However, you are always allowed to withdraw your principal investment from the account or make withdrawals in the case of an emergency.
Secondly, there is a limit on how much an individual can contribute to the IRA annually. One can only contribute $6,000 annually.
You do not have to put all of your money into a Roth IRA. However, I would definitely put some money away into this so you can take advantage of the tax-benefits. Even if you plan on retiring earlier, this would provide additional funds for later in retirement.
How to Open a Roth IRA
There are various platforms that offer Roth IRAs to its users. Some brokerages that offer this are WeBull and Betterment.
WeBull supports any IRA and provides commission-free trading and two free stocks when you sign up and deposit $100. If you are interested in creating an IRA and collecting two free stocks with WeBull, click here to sign up.
Betterment is another trading platform that offers IRA options. The platform also offers a high-interest savings account, which could also be an interesting option for an emergency fund. It should be noted that, while Betterment is commission-free, they do charge a yearly fee of 0.25%. If you are interested in creating an account with Betterment, click here.
At this time, Robinhood does not offer IRA or retirement options. This is unfortunate, considering how many young investors use its platform. However, I expect this to change very soon. The platform has been constantly upgrading its services, all while providing a free stock for signing up. To open a Robinhood account and collect that free stock, click here.
If you do not want to use WeBull or Betterment, there are other options available. Brokerages, such as Fidelity and Charles Schwab, also offer Roth IRAs. So, feel free to do your own exploring to see with which brokerage you’re most comfortable.
Allow Your Employer to Match with a 401(k) Plan
A 401(k) plan is offered by most private-sector employers. Like IRAs, the 401(k) is an investment vehicle to plan for retirement. It is not an investment itself. There are similar plans available for public sector employees, too. Click here to learn more.
The biggest perk with these accounts is the employer match.
Many employers actually match up to a certain percentage of their employee’s contributions. What does that mean? Here is an example: let’s assume that a company has a matching program, where if an employer contributes 6% of their check, the company will pay an additional 3%. If an employee, who makes $100,000, contributes 6% of their salary ($6,000), then the employer would contribute an additional 3% ($3,000) on their behalf.
So, by just making contributions to your 401(k) account, you can receive free money from your employer. That is HUGE! Doing this over time can have a tremendous impact on your retirement savings.
You do not have to put your entire salary into this account. (In fact, you are not allowed to, since the maximum contribution for a year is $19,500.) Instead, you can just contribute enough to take full advantage of the matching program provided by your employer.
The Holy Grail of Retirement Planning: a Roth 401(k)!
Yes, Roth 401(k)s exist. Like a Roth IRA, all gains realized within a Roth 401(k) account are TAX-FREE!
So, if you were to utilize this account, you would be able to take advantage of both the employer match and tax benefits. For this reason, this is probably the most ideal retirement account.
Not all employers may offer this, but, if they do, you are definitely inclined to utilize it.
The age that one can withdraw from a 401(k) plan is 59½. If withdrawn earlier, there is a 10% penalty implemented. However, after 70½, one must withdraw a required minimum distribution (RMD) from their plan. There is also a contribution limit of $19,500, so you would need to put your money elsewhere once you hit this amount.
Another negative is that the 401(k) is not as self-directed as an IRA. Your employer has much more say in what you invest in, as they have the ability to limit your investment options. For example, many 401(k)s have their investments limited to company stock and mutual funds. This would prevent you from investing in any stock that you wish.
However, not all 401(k) plans are like this, and many allow employees to invest in practically anything they want. Plans vary from company to company, so read into the plans that are available to you for more.
Lastly, it is rather difficult to open your own 401(k) if your employer does not offer one. Unfortunately, without being provided this plan by your employer, you most likely will be unable to open a 401(k).
However, there can be one way to open your own 401k, but it may be difficult. If you are self-employed, you could take the necessary steps to create your own 401k. This could be helpful to those who otherwise would not have a 401(k) available to them.
Create Your Own Income Streams for Retirement
What if you do not want to wait until 60 to retire? Well, you have to start planning right now. The best route to do this would be to create reliable income streams now, so you can be financially independent later. This would allow you retire from your full-time job whenever you want and rely on the cash flow provided from these income sources.
Two of the easiest streams of income to create are with real estate and with dividends.
Dividends are Fantastic
Some publicly-traded companies pay shareholders a part of their earnings. This payment is called a dividend. Many stocks pay dividends to their investors. Typically, they are paid every three months, but some companies pay as often as monthly. Click here to learn more about dividends.
For these payments, you do not have to do anything aside from owning the stock. That means, for as little as $1 (with fractional shares), you could start building yourself a stream of income.
If you were to constantly reinvest your dividends, you would only increase your returns tremendously. This is definitely a long-term approach, but it can be a very reliable source of income down the line.
Also, you benefit in two ways, as you receive dividend payments and realize appreciation for your investments. In other words, in addition to receiving a dividend, the price of your stocks can increase, which results in a gain on your investment.
Further, dividend stocks tend to be less volatile than non-dividend-paying stocks. They also tend to outperform the market during economic downturns. Lastly, blue-chip companies that pay dividends tend to continuously grow their dividend payments year over year. This means that your annual payouts increase yearly, if you invest in the right companies. To see a list of these companies, click here.
Use Your IRA or 401(k) for Dividends
You could also invest in these dividend stocks within your Roth IRA or 401(k). In a Roth IRA or Roth 401(k), all dividend payments received would be tax-free, in addition to any gain on the stock. This means that you would only have more money to reinvest into your stocks, which would allow compound interest to have a greater effect.
With a 401(k), you would be able to purchase even more shares due to the matching program. This too would allow you to increase the effect of compound interest on your portfolio.
There are two downsides when it comes to dividend investing. First, this form of investing is a long-term approach. However, this is true for all forms of investing. Unless you want to do day-trading or trade penny stocks, which I recommend you don’t, then there is no quick way to wealth on the stock market.
Second, dividend stocks will not lead to tremendous returns like some non-dividend-paying stocks. While they are safer investments to make, they, in turn, lead to smaller returns in the short-term. For example, tech companies, like Amazon ($AMZN), do not pay dividends. Their stocks have performed exceptionally this year, and not investing in them would have been a missed opportunity.
However, it should be noted that investing in these stocks does not allow you to feel the benefits of compound interest. You would not be able to reinvest dividend payments, which can increase your returns tremendously over the long-term.
Regardless, I still believe that dividend investing is a very good approach to creating a safe, growing source of income for the long-term.
Real Estate is Great… Just Costly
Real estate is a fantastic means for retirement planning. Most individuals do not consider real estate as a means to prepare for retirement, and I do not understand why.
One of the greatest obstacles to secure a safe retirement is finding a consistent source of income. When retired, you would most likely not be in the workforce, meaning you cannot rely on a paycheck for your expenses.
Investing in stocks can be an excellent approach to build wealth in the long-term, but it might not be the best in the short-term. The stock market can be very volatile, and relying on consistent yearly returns in the market could be rather risky.
With real estate, on the other hand, you would have a rather consistent source of income on a monthly basis. As long as you receive your rent payments, you would be able to have positive cash flow for your monthly expenses.
For older investors, this is much more feasible, due to the large upfront costs associated with real estate. However, it does not have to be this way.
What are REITs?
On the stock market, there are securities called REITs, which is short for “real estate investment trusts.” Essentially, a REIT allows you to invest in a portfolio of real estate. They are available for purchase with all brokerages much like stocks. An example of a REIT is Realty Income Co. ($O).
This lowers the barrier to entry tremendously while providing you with a monthly income stream. Additionally, you could invest in these REITs within your Roth IRA or 401(k). This would give you maximum tax benefits, an employer match, and a stream of income!
Even with this, I would still suggest for you to look at investing in physical real estate if possible. It could lead to great returns and be an excellent path to financial freedom.
The biggest drawback is that this is the only option listed here that requires actual work. This is especially true when compared to an IRA or 401(k). Landlords will have to deal with tenants, collect rent, and fix any problems with their property. Also, if you had to take out a mortgage for the property, that can be an unwanted burden as one nears retirement.
However, real estate has the perk of allowing the investor to leverage their money in ways that other investments cannot. Through a mortgage, an individual could essentially acquire the benefits of owning a property by only putting down 10%-30% of the total value.
Disclaimer: This is all opinion and not financial advice. I am not a financial professional.
It would be best to incorporate all three approaches into your retirement planning. A Roth IRA can be used regardless of your employment status, so I would open one as early as physically possible.
For a 401(k), you can only open one when you have an employer that gives you this option. So, it would probably be best to open the Roth IRA while in college and stow away some extra cash you have into this account. Once you begin working full-time, you can open a 401(k) (hopefully a Roth 401k) and concentrate on that to receive the match.
Once you have either open, you can create your dividend portfolio or invest in REITs. I would also consider looking into creating a non-retirement portfolio if you are looking to retire earlier than expected. In this portfolio, you could also benefit from dividends and REITs too.
Real estate, in my opinion, would be the most ideal option, due to how many benefits it would provide. However, this is the most costly option listed. It would become more feasible the older you get. However, if I were to recognize a good deal on the market, I would not hesitate to take action and secure an income stream that could provide me financial freedom.
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