New Year’s Resolution Workshop #1: Get Started with Retirement

new year's resolution workshopOver the next few days, we’re going to take a look at five common New Year’s resolutions that people often adopt for their finances, evaluate some of the traps that people fall into with regards to that resolution, and come up with some real actions that can turn a challenging New Year’s resolution into a success.

Retirement planning is one of those painful things that we all know we should be doing, but for those of us who started our careers with a routine of not saving for retirement, it can be a painful subject to consider. Yet another drain on my current paycheck? It doesn’t sound like something that many of us would look forward to.

Because of this tug-of-war between a recognition that we need to save for retirement as opposed to a desire to maintain as much take-home pay as possible, people often resolve to make the coming year one where they finally take charge of their retirement planning, but often it’s a resolution that falls short. They find little things standing in their way and use that as a reason to not take control of the situation.

No more. If 2009 is going to be the year when you take control of your retirement, you need a plan. Here are some simple steps you can take to get a retirement plan in place for yourself, no matter what your situation is.

First, find out if your place of employment offers a retirement plan. Likely, you already know this – if you don’t, your supervisor and find out who you can to find out more. Many workplaces offer some form of a 401(k) or 403(b) retirement plan which is very easy to participate in.

If you do find that your place of employment offers such a plan, get signed up as soon as possible, even if you’re unsure how much you will be contributing to the plan. You’re better off getting the plan in place now, since you can change your contributions later on. Actually signing up for the plan should also be straightforward – if you need help, ask for help from the person who gave you the forms.

How much should you contribute? This is the stumbling block that catches many people and keeps them from actually pulling the trigger. They consider contributing 5% to a 401(k) plan, but when they envision their paycheck dropping by that much, they don’t even want to think about having to deal with that kind of pay cut.

First of all, your paycheck won’t actually drop that much. For example, if you contribute 5% of your paycheck to a 401(k) or a 403(b) plan, your take-home pay will only go down 3 to 4%. Why? The 5% is taken out before taxes. Let’s say you earn $10 an hour, earning $400 a week, and 25% of that is eaten up by taxes of various kinds. That leaves you with a $300 paycheck at the end of the week, right? Well, let’s say you elect to contribute 5% of your pay to a 401(k) plan. You earn $400, then 5% of that is taken for the plan, leaving you with $380 in pay and $20 contributed to the plan. Then, 25% of that is taken in taxes, leaving you with a take-home of $285. You were able to contribute $20 to your retirement, but your take-home only went down $15. (In fact, it might even be better than that, because likely you’re going to have slightly less of your check taken out in taxes, but that’s a much more complicated story.)

Second, the reduction in your paycheck will be easier to handle than you think. Whenever a person’s earnings fluctuate a bit, their spending almost always automatically fluctuates to keep pace with it, and it’s often not noticed at all. In the example above, the $15 difference in paychecks would likely quickly evaporate in the form of different food purchases, for example.

So, how much should you contribute? For most people, 10% is a good number to target when you’re first starting out. Some employers actually match your contributions, so you can include their matching in that 10% – if you contribute 5% and they match 5%, there’s your 10%. If you’re over 30 and you haven’t started yet, you should look at a bit higher number – 12% or 15% might be better for you.

Even if the percentage seems painfully high, give it a try and see how it works. You might find that it’s easier to deal with than you think – and if it’s not, you can always request to lower your contribution percentage.

What if I don’t have a 401(k) or 403(b) option? Your best option is to start a Roth IRA, which is an independent retirement plan you can easily set up yourself. I recommend using Vanguard to manage it – that’s the group I use. You’ll have to make contributions to this plan directly from your checking account – I have a small amount withdrawn each week for my Roth IRA. They do all of this automatically for you – you only have to set it up once, then you can forget about it.

How should you invest the money? For most people, the easiest solution is to simply put all of one’s contributions into a “target retirement” fund. Most retirement plans offer several of these target retirement plans, which are intended to automatically manage your money over time, helping you get big growth early on, but slow down and become more stable as you near retirement. Pick the one with the year that’s closest to when you turn 65 – for example, if you’re 25 in 2008, you’ll be 65 in 2048, so you should choose a Target Retirement 2045 or 2050 plan. If you don’t have a “target retirement” plan, go conservative. Put 50% of your contributions into one of the stock options (preferably whichever one is the broadest one) and 50% into one of the bond options (again, whichever one is the broadest). This is a pretty conservative choice, but it will keep your money fairly safe no matter what the future holds.

The bottom line is to just take that first step. Even if you’re not contributing much at first, at least you’re setting up the plan and making a start at things.

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