How to Start Saving For Retirement

Perhaps you heard it from your parents, some guy you know who “really has it together” or maybe you’ve read it on a blog like this one. Regardless of where you got the advice: You know that it’s never too early to start saving for retirement. That means if you have a steady job, you should start to save for retirement

. But how? We get more questions about retirement savings—including 401(k) plans and individual retirement accounts—than any other topic. And no wonder: It seems complicated, it’s boring as hell and, at the end of the day, retirement seems like a long way off when you’re in your twenties.

No matter. You can learn how to start saving for retirement in the five minutes it will take you to read this article, and you can probably start doing it in less than an hour. So if you know that you should start saving for retirement but have no idea where to start, roll up your sleeves, brush off your fear and let’s get started.

Retirement Savings 101

Okay, so why do you even need to save for retirement, anyway? Because lucky for you, thanks to our modern quality of life and medicine, chances are good you will live to a ripe old age. And when you’re approaching 80, you may want to do something other than work. And although Americans receive Social Security benefits after a certain age, our younger generations cannot count on these government benefits alone. They won’t be enough to live on if they’re still around at all. We need to take charge of our own financial future and we do that by saving for retirement. The government will even give us some tax benefits if we do.

Finally, the earlier you start saving for retirement, the better: The more time you let your investments grow, the less money you have to stash away in the first place. (For more about retirement saving basics, read 23 Things Every Beginner Should Know About Retirement Savings).

How to Start

Anybody can start to save for retirement. We’ll cover the two most common ways.

The 401(k) Plan

If you work full-time, ask your human resources manager if your company offers a 401(k) plan or 403(b) plan (if you work at a non-profit). These plans allow you to save for retirement with automatic deductions from your paycheck up to $16,500 a year (in 2010). The best part is you do not have to pay taxes on the money you save. Even better, some employers will match some of your savings (usually a percentage of your salary). When you enrol in your company’s 401(k) plan, you will need to choose among a limited number of investments your plan offers (typically, you are limited to a few choices). Ask to speak with your plan manager for recommendations, or simply choose a target-date mutual fund for the year you will retire. These funds are collections of investments that the plan continually adjusts to maintain appropriate risk and return for your anticipated retirement year.

The Individual Retirement Account (IRA)

If your employer doesn’t offer a 401(k) or 403(b) plan or you want another option, start an IRA. You can open an IRA for free and often with no minimum deposit at most any online broker and can invest however you want (in any stock, bond, mutual fund, ETF, etc.) Investors under the age of 50 can contribute up to $5,000 a year (for 2010) to either a traditional IRA or a Roth IRA. These two types of IRAs often confuse new investors, but choosing can be easier than you think:

• Traditional IRA: Money you put in is tax-free (you can deduct the contributions on this year’s tax return). Choose a traditional IRA if you don’t have a 401(k) or other retirement plans at work.
• Roth IRA: You cannot take a tax deduction for the money you put into a Roth IRA, but you won’t have to pay taxes on the money you withdraw in retirement. Choose a Roth IRA if you do have a 401(k) or other plans at work and you do not earn more than the Roth IRA income limits.

Upon opening an IRA, simply set up automatic investments: transfer money from your checking account to your investment account every month or pay period and forget about it, just like employers do with 401(k) plans. Finally, whichever type of IRA you open, you will need to choose how to invest the money. Choosing from the entire universe of investments is more intimidating than selecting from among a few mutual funds in a 401(k) plan, so proceed carefully. You can research investments yourself using a free tool like Morningstar or enlist the help of a financial advisor (paying an advisor big bucks in your twenties rarely makes sense, but you might pay a fee-only planner for an hour session once a year to help you pick out your starting investments). Whatever you do, resist the urge to do a lot of trading: Even if you get lucky, the commissions and fees will eat up your returns, especially when you’re just starting out.

That’s really all there is to starting to save for retirement. Whether you sit down with your HR person at work or open an IRA account at an online discount broker now, you can probably be saving in less than an hour. The only question is: What are you waiting for?