When do I need to save for retirement?

Retirement seems a long way away for many of us. In fact, many people reading this may still be in school preparing for their first full time job. The average retirement age in the United States is 62. The average life expectancy in the United States is 79. Generally speaking, you will need enough saved to support yourself for around 17 years in retirement. This may not seem like a difficult task, but with the changes in technology and medicine, it is not absurd to think that we could live to well into our 80’s and 90’s. Having enough money saved to support yourself for over 30 years now seems like a daunting and scary task!

Many plan to travel and live a comfortable lifestyle once they retire. The truth is you must allocate your funds effectively for years in order to achieve this. You must plan for all the unwanted expenses, such as medical expenses, that will occur as you age. Many people forget that your expenses will increase during the later years of your life. You will be more likely to get ill, which could cause thousands of dollars in medical bills. You may need to live in an assisted living home towards the end of your life. The average stay in an assisted living home in slightly over two years! This can easily add up to over $100,000 as the average cost of assisted living per month, in Illinois, is $4,050. According to AARP, they project that the average 65 year old couple will occur $240,000 of medical expenses in retirement. If you do not think about what can go wrong right now, you are putting yourself at a major disadvantage.

The short answer to our main question is as SOON AS POSSIBLE. The earlier you fund your retirement and other savings accounts, the more your money will grow. As you can see, the earlier you put your money away, the more you will see the beauty of compound interest. Investing in retirement at a young age will give you a huge advantage, which you will realize later in life. If you start saving for your retirement regularly in your early 20’s, you will be able to accumulate a solid foundation for the future. Saving a few hundred dollars a month and putting it in a retirement account may seem unnecessary to a 20 year old, but you will thank yourself when you begin to think about retirement. It is never too late to save for retirement; someone in their 30’s or 40’s could retire in their 60’s if they fund it efficiently and effectively. One thing is for certain, they will need to increase their average contribution compared to someone in their 20’s, as they will not be able to fully take advantage of compound interest.

To conclude, in order to plan for retirement you must start saving early and often. You will also need to think about unwanted or possible future expenses such as assisted living. Keep in mind the quality of lifestyle you want when you retire. Do you want to buy a new home and travel the world? Or are you content downsizing and living a simpler lifestyle? Hopefully after reading this you are more aware of how to save for retirement and why it is so important.

Written by: Kevin Kawarski, Financial Wellness Peer Educator, University of Illinois Extension, Spring 2018

Reviewed by Kathy Sweedler, Consumer Economics Educator, University of Illinois Extension.

What is the Time Value of Money (TVM) and how does it impact my investment?

The Time Value of Money (TVM) refers to situations involving the exchange of something of value (money) at separate points in time. Basically all investments relate back to the exchange of money at a certain point in time for the rights to the future capital associated with that investment. In very simple terms, the TVM proves the idea that a dollar today is worth more than that same dollar amount tomorrow; it shows the impact that time has on money.

For example:

Say you are considering putting $10,000 dollars into a savings account today that would earn 3% interest.

  • In 1 year that $10,000 dollars would be worth $10,300.00
  • In 5 years that $10,000 dollars would be worth $11,592.74
  • In 10 years that $10,000 dollars would be worth $13,439.16
  • In 20 years that $10,000 dollars would be worth $18,061.11

As you can see above, because interest (earned in one year) continues to earn interest (later years), your original investment grows by just letting the TVM work its course. This is a very basic example, but it shows the importance of the TVM and how it can impact your investment.

So remember, take advantage of time! The more you invest now, the more that investment will grow in the future.

If you would like to see more real life examples schedule a “Steps Toward Investing” workshop with the Financial Wellness Peer Educators where we can talk more about the effects the TVM can have on a portfolio or retirement account. You can also schedule a one-on-one appointment with a peer educator by emailing financial.wellnessuie@gmail.com.

Written by Brandon Wyeth, Financial Wellness Peer Educator, University of Illinois Extension, 2017.

Reviewed by Kathy Sweedler, Consumer Economics Educator, University of Illinois Extension.

Early In My Career: Is it necessary to understand the difference between a Traditional and a Roth IRA?

During our college years the thought of retirement is way down the road, so far down the road, a lot of college students and recent graduates don’t even bother thinking about it. There is a false notion that people do not need to start thinking about retirement until we are well into our careers. However, becoming aware of what retirement plans can offer and contributing to them early can make your retirement that much more enjoyable.

Many people are confused about the difference between a Traditional and a Roth IRA, or if a difference even exists between the two. An IRA is an abbreviation for Individual Retirement Account; it is available for any working Americans. The two most common IRA’s are the Traditional and the Roth IRA.

In a Traditional IRA, the account owner puts pre-tax dollars into their account. Once the owner withdraws their money from the account they then pay ordinary income tax on the withdrawals.

In a Roth IRA the individual pays tax on income, then puts after-tax dollars into their Roth account. If the money has been in the account for at least five years and the owner is 59 ½ years old the principle and earnings are both tax-free when they decide to withdraw from the account. Roth IRA’s are typically a good idea for young people because they have many years for earnings to grow tax-free. Roth IRA’s also appeal to those who believe their tax bracket is likely to be higher in the future.

For more details about the differences between the two, read Traditional and Roth IRA’s, https://www.irs.gov/retirement-plans/traditional-and-roth-iras

 

Written by: Brandon Wyeth, Financial Wellness Peer Educator, University of Illinois Extension, 2017

Reviewed by: Kathy Sweedler, Consumer Economics Educator, University of Illinois Extension, 2017

Long-term savings and investing

401 (K)

What is a 401(K)?

A 401K is an employer sponsored savings plan. As an employee, you decide how much you want to contribute to your retirement plan each month and your employer automatically deducts this amount from your paycheck. The employer then puts this money in the 401(K) where it can generate returns. The money can be invested in a variety of ways including mutual funds of stocks and bonds. Although the employer is the one that puts the money in the account, you as the holder of the plan determine how you want the money to be allocated among different assets.

What are the benefits of a 401(K)?

One benefit of a 401K is that you are not taxed on the money you contribute to the plan when you make the contribution. Even though it is technically income coming out of your paycheck, this money is contributed to the 401K tax free. Another advantage of a 401K is that many employers have a matching contribution plan. This means that the employer specifies some set amount that they will contribute to your retirement plan. For example, they might add 50 cents for every dollar you contribute, up to a limit.

How much can you contribute to a 401(K)?

If you are under the age of 50, you can contribute up to $17,500 (2013) a year. If you are 50 and older, you are allowed $up to 23,000(2013) a year to catch up. The more you contribute each year the better. Try to contribute the maximum amount if you can. You at least want to make sure you contribute enough to meet the requirements for your employer’s matching contribution.

Withdrawals

With a 401(K), you cannot make any withdrawals until the age of 59 1/2 years. If you choose to take money out of the account before then, there is a 10% early withdrawal fee. Once you turn 70 1/2 years old, you are required to start making withdrawals and there is usually a minimum amount you have to withdraw each year. When you make withdrawals is when you are taxed on the money. This money is included in your taxable income and it is taxed as ordinary income.

Roth IRA

What is a Roth IRA?

IRA stands for individual retirement account and it is another means to save money for retirement. You make contributions to your account but in contrast to a 401(K), these contributions are taxed at the time of the contribution. However, the money is not taxed when you make withdrawals.

A Roth IRA is different from a traditional IRA and provides many benefits for young people.

What are the benefits?

A Roth IRA can be beneficial to younger people. Although you are taxed on the contributions you make up front, chances are that you are in a lower tax bracket while making these contributions that what you will be in when you start making withdrawals in retirement. So in the long run, it is likely to save you money.

How much can you contribute to a Roth IRA?

If you are under the age of 50, you can contribute $5,500 (2013) a year. If you are over the age of 50, you are allowed to contribute $6,500 (2013) a year to catch up. There is no minimum amount required to contribute by federal law although the financial institution is likely to have a minimum amount to open the account. However, the more you can give the better.

Withdrawals

The rules for withdrawals from a Roth IRA are more flexible than those of a 401(K). First of all, withdrawals are not taxed since you were already taxed on the money when you first contributed it. The only stipulations are that you must be at least age 59 1/2 (or dead or disabled) to make withdrawals and the account has to have been open for at least five years. Another advantage of Roth IRA’s is that you are not required to withdraw money like you are with a 401(K). No matter how old you are, you can keep your money in the account and let it grow. For a young person who is concerned about locking up their money for decades, the Roth IRA offers more flexibility than other retirement accounts.

Distributions are deemed to come first from contributions. So if you needed to, you could withdraw all your contributions without any taxes or penalties, at any time. If you withdraw more than your contributions and tap into the earnings in the account, then you will owe taxes and perhaps an early withdrawal penalty if you don’t meet the age and 5-year requirement.

Here is a summary of the differences between a 401(K) and a Roth IRA in 2013:

401 (K)

  • Contributions Taxed? No
  • Withdrawals Taxed? Yes
  • Maximum Annual Contribution: 17,500 (or 23,000 if over age 50)
  • Withdrawal age without penalty: 59.5
  • Mandatory Withdrawals: 70.5

Roth IRA

  • Contributions Taxed? Yes
  •  Withdrawals Taxed? No
  •  Maximum Annual Contribution: $5,500 (or 6,500 if over age 50)
  •  Withdrawal age without penalty: 59.5
  •  Mandatory Withdrawals: Never

Written by Katie Leginsky, Peer Educator, Financial Wellness Program, University of Illinois Extension, 2012