Saving for retirement can be an uncomfortable topic. We often think it’s so far off that we needn’t worry about it now, or we feel we’ll never be able to save enough even if we try.
But the reality is we all can and should plan for retirement. And with the increasing costs of goods and services (especially ones that are important in retirement, like healthcare), it’s more important than ever to have a solid plan to allow your investments to grow over time.
Why start thinking about retirement now?
If you’re in your twenties or thirties and plan on retiring at 65, why worry about retirement now—30 or 40 years in advance?
Because of the power of compound interest.
Taking the S&P 500 as a general indicator of overall stock market performance: If 30 years ago you invested $1000 in the S&P 500, then (including growth & dividends) you’d have $16,800 today… a 17x growth! And if you had invested that $1000 40 years ago, you’d have $84,100 today.
A sound savings strategy involves continued saving over time, so let’s take a more realistic example.
Suppose you invested just $100 per month into the S&P 500 over the past 40 years, for a total of $48,000 invested. Today, that portfolio would be worth $683,000!
These numbers might seem fantastical, but they aren’t made up — they’re actual real numbers from the market.
What if the market goes down and I lose money?
The stock market is volatile, so your retirement investments can certainly lose value. But this actually makes it even more important to start saving early!
Let’s say you were unlucky and decided to put $1000 in the S&P 500 right at the peak of the great recession in October 2007. By March 2009, you’d have lost 49% of your investment’s value, but luckily, you were smart enough to be saving for the long term. Today, 12 years later, you’d have $2566 (more than double what you started with.) Historically, the markets have always trended upwards over long-time horizons, which makes it perfect for retirement savings.
Benefits & types of retirement accounts
If you’ve decided now is the time to open a retirement account, the next step is to decide what type of account.
Retirement accounts generally offer tax benefits. (That’s the government telling you it wants you to save for your retirement!) The ones we’ll talk about here all feature tax-free growth, which means you don’t pay income tax on any dividends or realized gains inside the account.
Additionally, pre-tax retirement vehicles allow you to deduct contributions off of your income, so you get to defer paying income tax on that money until you withdraw. Post-tax retirement vehicles are the opposite, allowing you to put your already-taxed money into the account, and withdraw it completely tax free in the future.
For the solopreneur, the most popular types of retirement accounts are:
- SEP IRA: A pre-tax account similar to a traditional IRA, allowing you to contribute up to about 20% of your profit.
- Solo 401(k): A pre-tax account similar to a 401(k) offered by large employers, allowing both an employer profit-sharing contribution and an employee contribution component.
- Traditional IRA: A pre-tax retirement account that (for 2019-2020) allows up to a $6,000 contribution, depending on eligibility based on income and other factors.
- Roth IRA: Similar to a Traditional IRA, but is post-tax. Notably, the Roth IRA has income limits, but they can be bypassed with a backdoor Roth, but that’s beyond the scope of this article.
If you’re just getting your feet wet, I’d suggest starting with a Roth IRA, because unlike other retirement accounts, you can change your mind at any point and take your contributions out without penalty.
For pre-tax savings, my retirement account of choice is the Solo 401(k). Because it allows up to a $19,000 employee contribution in addition to the profit-sharing piece, it allows a higher level of annual contributions than the SEP IRA. The Solo 401(k) also has other benefits like the ability for you to take loans from it. (Also, it avoids running afoul of the pro-rata rule if you ever want to do a backdoor Roth IRA.)
Open a retirement account and save!
It’s now simpler than ever to actually open an account and start saving. Several online investment firms offer a variety of retirement accounts. Two of my favorites are Vanguard and Fidelity, as they feature no fees for most things, are very easy to navigate, and are friendly to work with.
Once you’ve opened an account, the most important thing to do is to actually contribute money into the account and start saving. Many of us have seasonal or otherwise irregular cash flows, so it may make sense to start by contributing a percentage of your income to savings, rather than a fixed amount. Feel free to start small (say, 3-5% of your income) and increase it when you’re comfortable doing so — just a little bit every month adds up over time, as we saw.
And remember that every dollar in a retirement account means less taxes for you, so unless you enjoy giving away your money to the government, that alone should be a huge incentive to save for retirement!
There’s never a better time to start saving for retirement. Your future self will thank you immensely.
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