Investing: Start as soon as possible! The longer you wait, you will have to spend a lot more overall to reach the same goal. You can calculate how much you will need here. You can expect an average return on investments around 6% (business.com, 2013).
Pension Plan: Employers pay you a guaranteed lifetime income when you retire. Amount of payout depends on various factors. These plans are becoming less common.
401(k), 403(b), and 457 Plans: 401(k) plans (for private organizations), 403(b) plans (for non-profit, tax exempt organizations), and 457 plans (for government agencies and some non-profit organizations) allow you to make tax-free contributions (up to a specified amount) and go untaxed until you retire or take the money out.
- Some employers match your contributions up to a certain percentage of your salary. If so, take full advantage of employer matching.
Individual Retirement Account (IRA): This is a plan that you set up. You can only contribute $5,500 per year (irs.gov, 2015). Most banks/financial institutions can open an account for you. There are two types:
- Traditional IRA: Contributions are tax deductible; withdraws must begin between age 59.5 and 70.5 (withdrawals before age 59.5 subject to penalty); and taxes are paid on contributions and earnings when withdrawn.
- Roth IRA: Contributions are not tax deductible; contributions can be withdrawn at any time; earnings can be withdrawn tax free after five years from when you opened the account or after age 59.5 (no required withdrawal period).
- Traditional vs. Roth? This is actually a very complicated decision. We recommend consulting a financial professional to analyze your specific situation.
Watch out for Fees: Investments typically have management fees that are called an "expense ratio". Although they sound small, they can cost you thousands of dollars over time. Look for fees under 1% or lower. For example, if you earn 7% on your investment, a 1% fee will bring you down to 6% earnings.
Withdrawing Funds Early: This will result in a 10% penalty (exception: Roth accounts) in addition to the funds being taxable income. Because of this significant loss, it's rare that people withdraw funds before age 59.5.