Retirement accounts for newbies

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Signing up for an employer-sponsored retirement plan can be a little daunting for young workers. Merely deciding how much to invest can be a source of anxiety — after all, keeping up with daily expenditures is hard enough without worrying about remote concepts such as retirement.

But, here’s a secret — it never gets any easier, so it’s better just to get started.

Workers in their 20s to whom aging is still relatively hypothetical have the best shot at amassing serious amounts of money with little to no effort.

In just four easy steps youthful wage slaves can effectively begin building up the wealth that will one day liberate them from their oppressive corporate overlords and flimsy cubicle walls and into the free-wheeling world of retirement.

4 easy steps to start your wealth-building machine
It’s not rocket science; no genius necessary!
  1. Sign up
  2. Decide how much
  3. Choose investments
  4. Think beyond this life
Sign up

Get the forms and commit to filling them out and then returning them to HR. If your company doesn’t do auto-enrollment, then signing up for the plan will be the most difficult part of the entire process. As difficult things go, it’s not that hard.

“What you don’t want to do is get the packet and think, ‘Oh I’ll do it later,'” says Marguerita Cheng, a Certified Financial Planner at Ameriprise Financial.

Just do it and get it over with, urges Vincent Barbera, a CFP with TGS Financial Advisors in Radnor, Pa.

“If you have to save, you’re a little bit more resistant to doing it because you’d rather spend the money. But when you have it coming out of your paycheck and don’t see it, it’s easy. The hardest part is establishing the account — doing the paperwork,” he says.

Some plans require a decision straight off the bat by offering a Roth option in addition to the tax-deferred plan.

Barbera says choosing the Roth is no-brainer. “If your company offers that, you can’t hesitate, you have to take advantage of that. It is such a huge benefit,” says Barbera.

Most retirement plans enable you to save money on a pretax basis or offer an upfront tax deduction, but then you pay taxes upon withdrawal. In Roth 401(k)s and IRAs, you invest after-tax money, and all future earnings grow tax free.

“Up until about age 45, a Roth is most applicable because then you have quite a few years to allow that to work to your benefit because withdrawals are tax-free,” he says.

How much

Figure out how much to contribute, and avoid the extremes of putting in too little or too much.

“The first thing they ask when you’re signing up is, ‘How much you would like to contribute to your 401(k) plan?’ And a lot of people start out too low. They say ‘I don’t want this to compromise my net income, so let’s go 1 percent or 2 percent,'” says Vincent Barbera, a financial planner with TGS Financial Advisors in Radnor, Pa.

On the other hand, overzealous savers can end up contributing more than they really need to and tying up money that may be better used on the present.

“If you get a younger person in their 20s and they start plunking down $15,500 a year with the employer match (the maximum allowed by law), they have a good chance of dying with about $20 million in the bank. And you don’t really want to do that,” says Frank Boucher, a Certified Financial Planner in Reston, Va.

Instead of feeling inadequate for being unable to contribute even near the maximum allowed or tossing in a tiny percentage of your income, at least put in just enough to get the match offered by the company.

“You don’t want to leave that money on the table,” says Boucher. “And then you can slowly work yourself up to about 10 percent of your income by increasing your contributions when you get a salary increase. Take a portion of that (raise) and put it in the 401(k) plan, and then use the rest to go out and spend.”

Choose investments

Many plans toss in 100 mutual funds and then say, “Here you go, pick some!” But it doesn’t have to be difficult, especially for young people with a very long investment horizon.

In general, having a broad exposure to the stock market will be best for young investors. Index funds offer low-cost diversification in a simple, effective package.

“The most important thing to take into account is a core investment. Some people are paralyzed with all the choices. It does more harm than good. So you should look at a core fund along the lines of a Vanguard 500 index fund or even a target-date retirement fund,” says Vincent Barbera, a Certified Financial Planner with TGS Financial Advisors in Radnor, Pa.

Frank Boucher, a financial planner in Reston, Va., also recommends that the majority of a young investor’s money go into a large-cap mutual fund.

“Most plans have an S&P 500 index fund or something along those lines and that is where the bulk of your money should go,” he says. “You can complement that by investing the rest into a small-cap, or small company option, if you have one, and an international fund option if you have those.”

If you don’t know the difference between a small-cap, a mid-cap and a bottle cap, a target-date retirement fund is an easy option. Basically these all-in-one mutual funds offer appropriate diversification for your age and change over time to more conservative investments as you approach retirement.

Though in general you do pay more for the convenience, these funds might be a good option for some.

“If you are confused and don’t know where to start, don’t let that be a roadblock. The fund company will make sure that you are diversified,” says Marguerita Cheng, a Certified Financial Planner with Ameriprise Financial.

Bankrate’s story on “Building a portfolio” provides more information about how to allocate your assets.

Beyond this life

If you don’t choose a target-date retirement fund, you’ll have to occasionally rebalance your portfolio. But aside from that, 401(k)s pretty much take care of themselves, save for one thing: designated beneficiaries.

Always make sure your beneficiary information is up to date. Though it seems like a hassle and a formality, in case something unforeseen does happen to you down the road, you probably won’t want your 401(k) going to parents who may have predeceased you or, worse, an ex-spouse.

Further, don’t believe that having a will solves the issue. Beneficiary designations best wills in legal showdowns as surely as rock beats scissors.

“Think about it carefully,” says Vincent Barbera, a financial planner with TGS Financial Advisors in Radnor, Pa. “It’s one of those little things you don’t consider, but you should.”

Besides that, just leave it alone. When it comes to making withdrawals, 401(k)s are effectively off-limits.

“A lot of individuals don’t understand the gravitas of 401(k) plans, and that it is something you should never ever consider dipping into except possibly — maybe — for a first-time home purchase,” says Barbera.

If you change jobs, either leave the account with the company or roll it over into an IRA.

“It’s easier to tap into an IRA than a 401(k) because it’s a little more flexible as to what you can use the money for. But, if you’re tapping into either, it’s basically 40 percent off the top, with taxes and penalties. If you take out $1,000 it will cost you $400 right there,” Barbera says.