Reaching for Retirement: From 401(k)s to IRAs

The Who, What, When, Where & Why to Saving for Retirement

Some mornings, I wake up to the sound of my retired father making coffee downstairs (Yes, I am 28 and still living at home with my parents) and ask myself — how? After four decades managing his own optometry practice in rural North Carolina, the jolly guy lives virtually stress-free. Mind boggling.

You know what’s even crazier? This could be you.

With a few “set it and forget it” strategies, you too can set yourself up for retirement — no lottery wins required.

Intrigued? Okay, let’s make this dream a reality. In the following three sections, I’ll be unpacking:

1. Retirement: Why It Matters
2. From 401(k)s to IRAs: Who, What, When, Where, How?
3. Ten Tips and Tricks

Don’t let the lingo scare you. With a few key clarifications, you’ll be on your way to Boomer-like bliss in no time. See you in 2060, Scottsdale! 🌵

Retirement: Why It Matters

The good news — saving for retirement is on many of your minds! In fact, 49% of Americans said saving money was one of their New Year’s resolutions for 2020. (Little did they know what was to come…)

If you’re already starting to strategize, good for you. Today, saving for retirement is more important than ever. With fewer employers offering pensions and retirement savings contributions, the onus is falling on you to plan for your future. Sigh.

Furthermore, if you’ve read the headlines over the past decade, you may have heard those scary rumors that “social security is running out.” While this may be an oversimplification, it’s true that millennials and Gen Z-ers will probably receive less social security support from the government than our parents got.

Sound as depressing as a Panic! At The Disco cover? While I won’t refute the conclusion, I can assure you that you’ve got what it takes to set yourself up for success.

Among a variety of supporting factors, successful retirement savings strategies predominantly rely on two key principles — (1) compounding and (2) tax advantages (feel free to use either term at your next Zoomtastic family reunion to make your mama #PROUD).

Compounding refers to the ability to generate incremental earnings from previous earnings. While this can sometimes get a bit confusing in the context of money, compounding makes a lot more sense to me when I think about it in terms of my social network.

If I make five friends this year, and they each introduce me to one new friend, then I’ll have ten friends next year. If each of those ten friends introduces me to one new friend the following year, I’ll have 20 friends at the end of year three. That’s four times as many friends as I started with (and it’s beginning to clog my iMessage inbox, but hey).

When applying this concept to your capital, look at it this way — if you invest $10,000 and let that money sit for 35 years (assuming a 7% interest rate), the money will be worth $106,766 in 35 years. That is 10.7x your money. VC investors, take note!

The beauty of saving for retirement is that your money is able to multiply in this manner over the course of several decades. It might not seem like much now, but it adds up to a LOT over time.

Tax Advantages are the government’s main way of encouraging people to save for retirement. While they might not be sending you a hefty social security check at age 65, the government does want to incentivize you to save for retirement, so they have established a number of tax advantages to entice you.

I expand upon these below, but I’ll give you the one liner here: free money. Pique your interest? Good, because it should.

Now that you have a sense of the Why, let’s explore the Who, What, When, Where, and How…

From 401(k)s to IRAs: Who, What, When, Where, How?

401(k)s, IRAs and HSAs… oh my! While you should not rely on my overview as a comprehensive assessment of every available retirement alternative on the market today, I am hoping to share a few of the most popular investment instruments so that the fancy finance acronyms at least begin to sound like plain English. The dream.

401(k)s

401(k)s are retirement accounts established by your employer. This means that every time you get paid, part of your paycheck is taken out and put into your 401(k) before taxes.

What does that mean? Well, you’ll only have to pay taxes on this capital when you begin to withdraw post-retirement. Many employers will also match your 401(k) contributions up to a certain percentage. And what does this mean? Free money!

So how can you get to work setting up a 401(k)? It’s easy. You just have to opt in when it’s offered to you by your HR department. Don’t work for a large employer with a formal program? Nbd. Even if it’s just a side hustle, self-employment income allows you to contribute to a solo 401(k) and a Simplified Employee Pension (SEP) plan. I’m probably not the best person to explain either to you, but know that they do indeed exist!

So what can you invest in? Typically a predefined set of mutual funds / target date funds / etc. that are determined by your 401(k) administrator (aka the Fidelitys and Vanguards of the world). These can come with slightly annoying fees and fewer options than the menu at Starbucks, but they still offer the potential for incredibly attractive returns over time.

So when can you access these funds? You can begin withdrawing from your 401k when you turn 59 ½ years old (aka the federally recognized retirement cutoff).

Note: you do have access to these funds ahead of your retirement date, but you risk facing early withdrawal penalties in most (but not all) scenarios. There are entire books written about 401(k)s, so I encourage you to do your own research, but hopefully this gives you the TL;DR on the instrument in general.

Individual Retirement Account (IRA)

Unlike 401(k)s, IRAs are not dependent on your employer and are available to everyone. You can set up an IRA at most financial institutions (think Schwab, Vanguard, E*TRADE, Wealthfront, Alto, etc.), and this account will allow you to save for retirement with tax-free growth (you pay taxes upfront) or on a tax-deferred basis (you can forget about taxes until you are sipping Mai Tais).

So how does this work? While there are more types of IRAs than Salt & Straw monthly flavors, the two most popular (and relevant) products are Roth IRAs and Traditional IRAs.

Roth IRAs involve depositing after-tax money and generating tax-free gains. If you are indeed eligible, Roth IRAs are a jackpot. So what’s the catch? The income restrictions. If you earn over $140K (as of 2021) as a single gal, you are SOL. Sorry.

That said, you still are indeed eligible for a Traditional IRA, which has no income limits. Unlike a Roth IRA, a Traditional IRA involves investing pre-tax dollars (your contribution is tax-deductible). Your money is then able to grow tax-free until you withdraw it (at which point you’ll pay income taxes).

Across both Roth and Traditional IRAs, your contributions are capped at $6,000. It might not seem like that much, but this $6,000 will be $83,969 by 2060 (assuming a 7% interest rate).

Again, you should do the work to better understand what makes the most sense for your unique situation, but keep in mind that with some deliberate deployment, you could afford a lot of Royal Caribbean cruises.

Health Savings Account (HSA)

Last but not least, the HSA… aka a very sneaky retirement hack. (Am I allowed to say that?) An HSA is a tax-advantaged account that lets you set aside capital to pay for healthcare expenses each year. You basically get the same tax deduction with an HSA as an IRA when contributing capital, but it comes back out tax-free if you indeed use the money for medical expenses.

As an individual, you can contribute $3,600 (as of 2021) per year, and funds unused for medical expenses over the course of the year may continue to be invested and grow over time. Yes, that means that you can use your HSA as yet another retirement savings account if you don’t use the money over the course of the year for medical expenses.

HSAs are subject to similar withdrawal considerations as your 401(k) and IRA, so don’t depend on this cash to fund next year’s trip to Cabo. That said, you have a lot more flexibility when it comes to medical expenses, so this pool of capital provides an attractive degree of optionality.

Where can you set up one of these sparkly savings accounts? HSAs can be established with banks, credit unions, health insurance providers, and more. If you work at a more established organization, I would recommend asking HR, who will likely be able to point you in the right direction.

HSAs are underappreciated by many (yeah, yeah, I’m on the Naughty List here), so don’t feel bad if this is your first exposure to their magic. Go forth and explore, ladies!

Ten Tips and Tricks

1. Start now. The most important thing you can possibly do is start saving today. The earlier you start, the less you actually need to save every month — unlike with those dark circles, time is indeed your friend here. As shown in the snazzy chart above, the beauty of compounding means that your money can grow a LOT with very little work on your end. Set it and forget it, and you’ll be on your way to that Early Bird special!
2. Go all in. Everyone has different means and priorities. I get it. But if you can, you should. The tax advantages (getting tired of me referencing these? Great!) and longer-term compounding potential of these accounts are more meaningful than many of us grasp (myself included, at times). While the numbers are indeed dependent on your individual financial profile and cost base, Fidelity’s rule of thumb is to save at least 15% of your pre-tax income each year for retirement. Regardless of where you fall on the ability-to-save spectrum today, do yourself a favor and do the research. I suspect that with time, you’ll come to many of the same conclusions that I have…
3. Max out that 401(k) match. FREE MONEY PPL!!! You should be contributing as much as you can to squeeze the most juice out of your company’s 401k match. What does that mean? If your company offers a 4% match, you should be contributing 4% or more of your monthly income to your 401(k). Not sure if you get one? Ask HR. Pretty sure that you don’t get one? Ask for one. Yes, it’s a bit #awks, but this is an amazing opportunity to optimize your income in a way that’s a win for both you and your employer.
4. Establish an IRA. Once you’ve hit your 401(k) match, most people will tell you to begin contributing to an IRA next (either Roth or Traditional, depending on your earnings profile). IRAs generally have greater optionality and lower fees than 401(k)s. As of March 2021 (our one year #ronaversary!), you can contribute up to $6,000 / year. If you can swing it, you should.
5. Invest toward your 401(k) max. Once you’ve hit your max IRA contribution, your 401(k) should be your next stop on your deposit journey. As of 2021, the max 401(k) contribution is $19,500. Again, if possible, you should be maxing this out. With compounding and pre-tax benefits on your side, the upside to losing access to this money today is worth it (for most people; I can’t speak to your specific situation).
6. Invest toward your HSA max. The final stop on the retirement train is your HSA. If you make it this far, dang gurl! Good for you. As of 2021, the max HSA contribution is $3,600. While HSAs are a lesser-known investment vehicle, they can be quite juicy if managed correctly.
7. Invest like the best. Yes, that means you should be investing in boring index funds and target date funds (my preferred instrument so that I don’t have to worry about portfolio rebalancing). Life is too long to play hero. Do not put your life (or at least that 2060 beachfront bungalow) on the line. Stick with those steady compounders, and watch out for fees. Though only a few basis points more (this means 0.01%, fun fact), higher-cost funds can cost you a LOT of money over time, and they frequently don’t even result in superior returns.
8. Consolidate. If you can’t remember your individual Netflix, Hulu and HBO logins, you’re unlikely to remember where all of your retirement investments are in 40 years. Consolidate your retirement savings in a single place. Change jobs? Roll your retirement account into an IRA. Not sure how to do this? Check out Capitalize for the answers to your prayers.
9. Do not touch. Unsurprisingly, the IRS is not your friend when you try to rewrite the rules of their retirement game. You’ll risk annoying early redemption penalties if you begin drawing from your retirement accounts early (though yes, these funds are indeed yours to leverage in case of emergency). There are some exceptions to these rules — certain medical events and education expenses allow you to withdraw penalty-free. If you’re considering withdrawing from your retirement funds, it’s worth evaluating your options to understand which will be the most tax-advantageous (or at least incur the fewest penalties).
10. Automate, automate, automate. You have better ways to spend your Sundays than worrying about retirement. Set up a system that works for you, and then leave it alone. Whether it’s automating your monthly 401(k) contribution or setting up recurring monthly withdrawals from your checking account, I would highly recommend removing yourself from the loop as much as possible.

While Current You might have missed the last four minutes of TikTok hype, Future You is #grateful for reading this far. (At least I hope!) Remember, it’s about consistency and not heroic efforts. You’ve got this 💪🏾

Interested in setting up an IRA? Or just eager to explore what options might be a click away?

Join my conversation with the one and only Tara Fung, Chief Revenue Officer of Alto IRA, on Tuesday, March 23rd to learn more: Alto + Money Moves