Retirement Planning Basics‍

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Hey everyone, welcome back! Today, we're switching gears to discuss something that might seem light years away, but trust me, it's crucial: Retirement Planning.

Planning for retirement may be the last thing on your mind when it comes to your financial goals. Times have changed—soaring student loans, sky-high rent. Saving for retirement often feels like a pipe dream. Did you know that only 36% of Millennials are saving for retirement, and for Gen Z, the numbers are even lower?

But here's the kicker: the sooner you start, the better off you'll be. Let me throw some numbers your way. Imagine you're 25 and putting away $300 every month. Assuming a 7% annual return on your investments, by age 65, you could have around $1.1 million. If you wait until you're 35 to start doing the same thing, you'd end up with roughly half that amount. So, the earlier you start, the more you benefit from the magic of compound interest. Of course, a 7% annual return is not guaranteed, but we use that to illustrate the importance of saving early.

You might wonder why you should even bother planning for retirement. Well, for starters, don't count on Social Security to be your saving grace. It likely won't be enough to sustain your current lifestyle. Unfortunately, employer pensions are not as reliable as they used to be. Many company's pensions are moving away from defined benefit plans. In defined benefit plans, your employer is the primary provider to your pension fund. They specify a benefit award for you upon reaching retirement age. However, defined contribution plans are unfortunately becoming the norm. In these plans, the employee shoulders the burden of contributions as these contributions are made by withholding a portion of your salary. The most popular defined contribution plan is called the 401 (k). Once again, we fall back on our essential rule–plan, do not hope.

So, that's the quick and dirty reason why planning for retirement is so important. In our upcoming discussions, we'll get into the nitty-gritty of creating a retirement plan, understanding retirement accounts like Individual Retirement Plans (IRAs) and 401(k)s, and breaking down the complexities of Social Security.

So stay tuned, and think about your future self for a second—they're hoping you're paying attention right now.

How to Create a Retirement Plan

Hey there, welcome back! Last time, we touched on why retirement planning is a big deal, especially when you are young. Today, let's get into how to create a retirement plan.

First things first, setting some goals is crucial. Do you see yourself lounging on a beach, or maybe you're the adventurous type dreaming of a retirement spent at sea? If so, you'll need a budget to make it happen. How much you need to live comfortably in retirement varies, but a common rule of thumb is about 70-80% of your yearly pre-retirement income.

Once you have a goal, the next step is figuring out how to get there. This is where things like budgeting and savings come in. Automating your savings is an easy, pain-free way to start. Just set a portion of your paycheck directly into a retirement account. Out of sight, out of mind, right?

Now, the big question: Where to save? You've probably heard terms like IRAs and 401(k)s thrown around. These are just different vessels to grow your money. If your workplace offers a 401(k), especially with an employer match, that's free money on the table—grab it! An Individual Retirement Account or IRA is another solid option, giving you more control over your investments.

You'll need to decide on asset allocation in the investment part. This is the mix of investments like stocks, bonds, and other assets in your portfolio. A riskier portfolio may get you higher returns but also comes with higher risk.

And hey, if this all sounds overwhelming, remember that Pave is there to help guide you based on your financial landscape. It's like having a co-pilot for your retirement journey.

That's it for today! Next, we'll dive deeper into different retirement accounts and make sense of Social Security. Until then, think about what retirement means for you and start taking those first steps to make it happen!

Understanding Retirement Accounts: IRAs, 401(k)s, & Social Security

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Hey, welcome back everyone! Last time, we covered how to create a solid retirement plan. Now, let's talk about where to stash your cash for the long haul—specifically, the pros and cons of 401(k)s, IRAs, and Social Security.

401 (k)s and IRAs are important because defined benefit plans are becoming a relic of the past. Now, only government-related jobs are associated with a defined benefit pension plan in the U.S. Employers used to guarantee a certain income and shouldered the risk of building up sufficient savings during the employees’ working years to afford to pay them a scheduled income in retirement. The risk of earning a sufficient investment return to achieve the goal of paying their employees either a lump sum at retirement or an annuity yearly has caused most employers to shift to defined contribution programs. The defined contribution plan relieves the company of any guaranteed payment at a future time. This is great for them, but not so great for you. In the defined contribution era, the contribution is known (because you, as the employee, define it), but the amount at retirement, the benefit, is uncertain. The burden of risk is now for you to

• Contribute a large enough amount each year to fund the account to a sufficient size and
• Earn a sufficient return on investment to allow the account to grow large enough to sustain you when you stop earning a salary.

If your company does not offer a pension plan or you work independently, you need to look at an Individual Retirement Account.

Assuming you have an employer and they offer a defined contribution retirement plan, then it is most likely a 401(k) plan. Offered through your employer, 401(k)s are a big deal because many companies offer to match your contributions. If you put in 4% of your salary, they might also put in 4%. That's free money! Make sure you find out what your employer offers. Another benefit is that the retirement savings account can grow without being taxed until you withdraw it, starting at age 59 and a half.

The downside is that your investment options are often limited to a list preselected by your employer. The usual suspects you can contribute to are stock and bond mutual funds (a portfolio of stocks and bonds) and money market funds (short-term, lower-risk, interest-bearing instruments). And let's say you decide to withdraw your money before you hit 59 and a half—you could be hit with penalties and extra taxes.

Even with some drawbacks, the employer supplement is very attractive. Look closely at this option if it is available to you. You are limited to a cap on how much you can save in a 401 (k) annually; there is currently a maximum contribution of $23,000 for those under 50 and a max of $30,500 if you are over 50. Due to those caps, you may also want to supplement this plan with your own IRA if you can afford it.

Ok, now, let's examine IRAs or Individual Retirement Accounts. Think of these as your DIY retirement savings. Unlike 401(k)s, you're the captain of this ship, which means you can invest in almost anything you like. The annual contribution limits are lower, but you have the freedom to pick and choose your investments. However, the tax benefits differ depending on whether you use a Traditional IRA or a Roth IRA. Traditional IRAs give you an upfront tax break, but your retirement withdrawals are tax-free with Roth IRAs. 401(k)s are also broken down into traditional and Roth classifications; with the traditional, the money comes out of your paycheck before taxes, reducing your paycheck. Therefore, the contributions to the traditional 401(k) are not taxed, nor are any interest or gains from stock appreciation before you withdraw money from your 401(k. Still, when you take money out to support your retirement, you are taxed.

The Roth 401(k) is the same as the Roth IRA, in that your contributions come from your paycheck after taxes are paid on that contribution amount. After-tax dollars are funded by the 401(k) and withdrawals are not taxed during your retirement years. If you can afford to wait, you do not have to withdraw anything from your 401 (k) or IRA before age 73.

There are a few ways to decide between the two plans. If you think you will enjoy big returns over time and are investing early in your career and your current tax rate is low, a Roth 401 (k) or Roth IRA is the way to go because your final amount will be large. You may prefer to avoid paying taxes once you are retired, even if you may be in a lower tax bracket during retirement age. Due to budget constraints when you are young, however, you may prefer to simply adopt the traditional 401(k) or IRA option because you will pay fewer taxes upfront.

If you are under 50, the total contributions between yourself and your employer cannot exceed $69,000 in a given year, meaning your maximum is $23,000, and your employer can give up to twice your contribution, or $46,000. For those above 50, it is $76,500 (you max out at $30,500, and your company can provide $46,500. Typically, your employer can choose to match your contributions dollar for dollar or may choose to provide a particular fraction of what you put in annually. If you own your own business or are just solo, you can open an independent 401 (k) or a “One-Participant 401 (k) plan.”

Anyone who earns money can start and contribute to an IRA, and as we already mentioned, that goes for those who also have a 401 (k). IRAs were originally designed for the self-employed who did not have access to the universe of 401 (k) retirement plans. There are four basic categories, and the first two we have discussed are traditional and Roth, which are available to individuals. Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plans for Employees (SIMPLE) IRAs are available to small business owners or self-employed individuals. There is an important fifth category, the self-directed IRAs (SDIRAs), where you make all the investment decisions and can even invest in commodities or real estate.

SEP IRAs can be set up if you are a freelancer/independent contractor or own a small business. Whereas you can put in $7,000 in a traditional or ROTH IRA annually ($8,000 if you are over 50), a SEP IRA allows you to contribute up to 25% of your income, although the amount cannot exceed $69,000. SIMPLE IRAs have a limit of $16,000 ($19,500 if you are older than 50). So you can look at a SEP IRA as being closest to a 401 (k) in terms of allowing you to contribute a lot of money annually if you can afford it.

Before we jump into Social Security, here's a quick investment strategy tip. A standard recommendation is to first invest in your 401(k), especially if your employer matches contributions.

Last but not least, let's chat about Social Security. It may seem like a reality that is ages away. But the sooner you understand it, the better. Funded through payroll taxes, Social Security provides you with monthly income during your retirement years. The caveat is that the system is under a lot of strain, and the amount you'll get depends on your earnings over your lifetime. So, while it's a helpful supplement, it's not wise to make it your only retirement plan.

Now, how does Pave fit into all this? Pave offers an excellent way to diversify your investment approach. You can either set it to autopilot and let the platform operate independently or manually execute trades based on personalized recommendations. It complements your retirement accounts by adding an active or passive layer to your broader financial strategy.