Life Kit - Retirement 101: How To Save What You Need

Episode Date: July 9, 2021

It's never too early to start putting away money for retirement. In this episode, NPR's Chris Arnold decodes what you should know — from the types of retirement accounts to strategies for saving. (This episode originally published in October 2020.)Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is NPR's Life Kit. I'm Chris Arnold. When did you first start thinking about saving money and figuring out how to do that the right way for retirement? Okay, so in the crib, I asked for a bottle of milk and a 401k. That's Michelle Singletary. She's got a personal finance column for The Washington Post. And we'd love to have her on Life Kit just because she's awesome. And Michelle says that when it comes to setting yourself up for retirement, some people are just kind of born to do this. They just get it.

If you have a parent and you take your kids to swim class for the first time, there's some kids who just jump in and it looked like they came out the womb knowing how to swim. And those who are just flapping around and those who are just standing on the edge thinking, you are not getting me in this water at all. And I was the first kid. Okay. So maybe when it comes to retirement, you're still kind of at the edge of the pool, dipping your toe in. It's like, oh no, this is the deep end. There's all this stuff I don't understand. That's okay. Michelle wants you to jump into the retirement savings pool because there's just so much to gain if you do it. And especially if you do it when you're still young. So, you know, one of the questions that people often ask financial experts

or finances is how do I become rich? Like what they think there's some sort of secret to it, that there's a stock that they don't know about or a mutual fund or, you know, there's a secret path that rich people are keeping from us. But if you're young, here's the secret. You ready? You're young. That is your advantage. That is your secret stock. This episode of Life Kit, Retirement Savings 101. We're going to help you understand why you need to start investing for retirement now, how to pick the right accounts, and how to manage the money right. So like we were just talking about with Michelle, it's really important to start saving for retirement as early as possible.

And that's because of the magic of what's called compound interest, which sounds like, oh, my God, that's really boring. But actually, it really is magic. I like compound interest because basically your money is earning money on your money. Basically, the stock market usually gives you about a 7% return on your investment each year. And in one year, it might be 30%. And next year, it's down 20%. But over time, it averages out to about that.

And that means your money is growing pretty quickly over time without you doing anything. Your money is working for you. You are not working for your money. You don't have to work an extra hour to make more money on that money. That's compound interest. So let's say in your early 20s, you scrape together a couple hundred hours out of each paycheck and you put that into a retirement account. And you know, that's people don't have kids yet a lot of the time. And it's not crazy to think that you could do that, right? And so what that means is by the time you're 30, you could save up about $50,000.

And it sounds like a lot of money, but it is possible. And then when you invest that money at 7% of the stock market, it's going to double about every 10 years, thanks to compound interest. So by the time you're 40, you got $100,000, and it doubles again and again and again. And then by the time you're 70, ready to retire, you've got $800,000. And all you did was set aside $ grand so many years before. And you'll probably have twice that because you're saving other money all along the way too. But it's that initial money that you save that has time to get really, really big. Michelle, you like to say a secure retirement doesn't happen by accident. What do you mean by that?

Well, you know, wealth doesn't happen by accident. You have to actively do things to build your wealth. Many companies now, if you work for a company that offers a retirement plan, will have a default for you. And usually default is anywhere between maybe two and 5% of your take-home pay to investing, but that's not going to be enough. So it's great that you're investing for your retirement, but most people don't go back and look to see, is that percentage of my pay being put to my retirement going to be enough? So you have to go in and increase that default. You know, do it one percentage per year or one percentage every other year.

That's one thing. And then you have to understand what's in your retirement plan. Many people sign up and they never really go back and revisit how they're being invested. So you've got to inform yourself. But it's not like you go get a lotto ticket and you become rich instantly. Wealth doesn't happen that way. All right. So Michelle is talking about people who are lucky enough to have an employer that defaults

them into a pretty good plan to begin with. Many companies who have a 401k or a 403b, or if you work for the government, a TSP, their savings plan, will set it up automatically. They'll hire a management company, a financial company, to manage the plan. So that company makes sure your contributions come out, they get sent to the investments that you want, they take care of the back office stuff. All you do is say, hey, I want $200 every paycheck to go into the account. Boom, done. It's done. If they have a match, that's a bonus. But the reason why you want to participate, even if there's not a match, is because that automatic thing helps you save. Studies show that when people are able to automatically save from their paycheck through

their employer, it gets done. It gets done consistently. Now, let's say you work for a company that doesn't have a retirement plan. You still can save for retirement. You can do an individual IRA, individual retirement account. And now you don't have the same automatic from your paycheck, but you can set it up that way. You can set up your checking account to automatically send money to that IRA. With an individual IRA, you're limited to $6,000 a year or an extra thousand, 7,000 if you're 50 or older.

And also the bonus is if your company matches what you put in, that's just free money. That's just putting money on the table. So take that money off the table. I find that that's the best way to encourage people to save for retirement and save consistently. Yeah. And we've got a whole episode, Juwan, how to divide it up. I mean, stocks versus bonds versus real estate investment trusts. And we can't get into all of that.

The one takeaway is cost is everything. You know, you want the lowest fees possible in a lot of these accounts, especially if you're investing in the stock market. You want broad-based index funds, which can cost next to nothing. To zoom in on for a freelancer or somebody who doesn't have the match or doesn't work for a company that has any plan, there's the IRA, there's the Roth. I remember when I was self-employed, there was the SEP IRA. How does somebody in that situation choose between the Roth or the IRA or the SEP IRA?

So all of those instruments, think of those as a pot. So individual IRA, individual retirement account, it's a little different than a Roth because you can take a tax deduction for the IRA, depending on your income. The Roth you pay after tax. So you pay taxes on the money, then you invest it. And then if you're an individual who's self-employed, you can basically create your own 401k through a SEP. So they're all just ways to save for retirement and it's a different sort of pot. Now there's a big debate about whether you should do a Roth or a 401k. It's the whole point of pre-tax versus after-tax. So honestly, when you look at the numbers at the end of the day, doesn't really make a difference. The Roth is better for young folks because your tax bracket

is lower. But if you're in a higher tax bracket, personally, I'm going to put off paying taxes as long as I possibly can. But if you're in a lower tax bracket and you're in a higher tax bracket when you retire, because you were young when you started, now you're in a higher tax bracket when you retire because you were young when you started, now you're older, it's a little bit more of a benefit for you because you don't have to pay taxes on the end when your tax rate is higher. Right. And you could do a Roth when you're young because you pay the taxes on the front end when you're not paying much in taxes because you're not making that much money, which lets you pay no taxes when you take it out when you're 65 or 70 or whatever.

Okay, that little pot of money, you can win that way. And at some point, you switch over, you get hired, you get a 401k. Okay, you're doing that too. And so you can have multiple, multiple vehicles. Yeah, but y'all don't worry so much whether it's a Roth or IRA. Just save. Like, seriously, the difference is not going to be like one, you're going to have a million and the other one, you're going to have two million. Just save and watch the fees and save consistently and you will get there.

Right. And again, you know, making it automatic is so much more powerful than am I in a Roth or am I in this other thing? It's just like get that money machine chugging along on autopilot while you're just not even thinking about it. And that's how you're going to have a ton of money saved. All right. So how much money should people try to save? How do you help people understand what should my goals be here? So people like these benchmarks and I understand because it makes it easier for me, but the benchmarks will depend on where you're in life. So let's start with retirement. So Fidelity Investments

and many of the financial companies say, okay, you need to save about 15% of your gross pay for retirement. Now, most people, you're insane. But if you do it as a young person and starting out, hitting that 15% mark, you're going to have enough for retirement. Simple as that. But at some point, if you are already working and you've got student loans and all kinds of stuff, 15% is just not doable. So you have to figure out how much you can and then try to hit that 15% goal as you go along. So maybe starting out, you can only do 5%. Then the next year, see if you can push it to 6%. And then the next year, 7%. Or every other year. But try to reach that 15% goal as soon as you possibly can. One way I think we could wrap this up is that when people talk about motivating to save,

there's this thing about envisioning your future self. So I'm just going to ask you, Michelle, what is your vision of your perfect retirement, where you want to be, the vision of the future that you have for yourself? It's not a really good question, actually, because people say, well, how do you stay on track? How do you stay on track for your budget? How do you not fall off of it? Because it's so easy to fall off of it. Life happens. I think, what do I want to do and be? So I wanted my kids to go and not have that. And also to get out of my house because they get on my nerves. I have a wonderful,

fine husband and they don't like me kissing him all the time. So get your own house. So that motivates me to send them to college with no all the time. So get your own house. So that motivates me to send them to college with no debt so they can get out of my house so I can kiss my husband. I mean, I'm being real here. It's seriously true. For retirement, I love being by the ocean. I could literally sit in a chair at the ocean from sunup to midnight and just sit there. And I envision a retirement where I can, if not own a house at the ocean, at least spend a great amount of time during the year renting something at the ocean and afford it and not be worried about it. I also want to spend about half the year volunteering my services in prisons and in

communities and low-income neighborhoods teaching people how to handle their money. I can't do that if I'm worried about paying my bills. So decide what you want to do. Use those goals to keep you on track and motivate you to learn about this money and make sure you're doing all the right things with your money so you can sit by the edge of the ocean. That's Michelle Singletary. She's the Washington Post personal finance columnist. Okay, let's recap here.

Number one, start saving as early as you can. The magic of compound interest will help your retirement account essentially double every decade. Number two, if your company offers a match to your retirement contribution, you want to take the free money. That's not very complicated. Try to increase your contribution as well. Like if the default is we're going to start you saving at 2% a year, bump it up if you can afford more than that. Number three, Roths, 401ks, IRAs. These are all just different kinds of vehicles

to save your retirement into. Roths are pre-taxed, IRAs get taxed later. Michelle says, look, don't overthink this. And really, you just want to start saving money. Don't get confused so you don't do anything. Just start saving. All right, number four, aim to save 15% of your income for retirement. If that's

too much, it's okay. Start with what feels achievable and work your way up. And lastly, envision your future self, whether it's sitting on a beach like Michelle was talking about, or maybe for you, it's a cabin in the woods. Use your future self to motivate yourself to save more money now. There is so much more to talk about when it comes to savings. We have lots of other episodes on LifeKit to help you out. We've done episodes about building a buffer account, investing your retirement savings, like how to actually choose the right investments. That's really important. You should definitely check that out. How not to get screwed over if you're looking for a financial advisor because they can charge you way too much money and they have conflicts of interest. It's important to learn about that

stuff too. You can find those at npr.org slash life kit. And if you love life kit and you just have to have more, subscribe to our newsletter at npr.org slash LifeKit newsletter. And if you've got a good personal finance tip for us, leave us a voicemail at 202-216-9823. That's 202-216-9823. Or email us a voice memo at lifekit at npr.org. This episode was produced by the fabulous Megan Cain, who is also the managing producer. Beth Donovan is our senior editor. I'm Chris Arnold. Thanks for listening.