Congratulations! If you’re reading this, I’m guessing you’re a newly minted young teacher. If you are, I’m sure recently you received the age-old wisdom from Mom & Dad (or Grandma & Grandpa): “Make sure you start saving for retirement as soon as you can.”
Now we can’t fault them. Their intentions are good and it’s smart to start saving for retirement as early as possible. I get it though. You’re in your mid 20’s, and not a Financial Planner like yours truly, so thinking about retirement savings isn’t top of mind. But, you know in a few months they’ll ask about it, and you’ll want to have something ready.
Typically, your first opportunity will come in an employee orientation and goes like this. The HR rep will be flying through information. You’ll be trying to process everything and get your health insurance set up. Toward the end the rep will mention a 403(b) plan and you’ll think, “I need to do something for retirement savings. Here’s my chance, I’ll do that!”
But is that the best decision for you? Let’s take a look…
Take advantage of the match
The very first question to ask about a 403(b) plan is whether or not there’s a match. If there is, you should sign-up to take advantage of it. The match is free money, so it’s typically best to contribute enough to get the full amount your employer will kick in.
Make sure you know the details on how it works so you end up actually getting the full amount. For example:
Simple Match: You employer will match your contribution 100% up to 3% of your salary
Complicated Match: Your employer will match your contribution 100% up to 2% of your salary and 50% up to 4%.
In both cases, the full match is 3%; however, with the simple match you only have to contribute 3% of your salary to get the full match, while in the more complicated plan you’d have to contribute 4%.
Evaluate your options if there’s no match
The decision looks different if your 403(b) plan doesn’t have a match. You can still contribute to your employer’s plan. It’s convenient and you’ll receive a tax break for making contributions. But before you do this, it’s important to evaluate the investment options and costs in the plan.
Most plans will have a line-up of investment options. Even if you don’t know much about investments, get a copy of it. Then go to Morningstar.com and look at each one of the funds. On the top of each fund’s page, look specifically at three things: the star rating, the load, and the expenses.
If your plan is full of funds with 1-star and 2-star ratings, if any have a load, or if you see expenses consistently higher than 0.50%, you’re probably better off avoiding it. A plan with poor performing funds, sales loads, and/or high fees could cost you hundreds of thousands of dollars in lost retirement savings and severely limit the tax benefit of saving in the plan.
What are the alternatives?
If you’re not going to use your employer’s plan, you can still save for retirement, up to $5,500 per year in a Traditional IRA or Roth IRA. These retirement accounts can be set up through a Financial Planner or Advisor or on your own through a brokerage firm like TD Ameritrade, Charles Schwab, etc. Going this route will typically give you more investment options and lower fees and expenses compared to investing in a poor employer plan.
It’s important to research which type of IRA will be the best fit for your situation. For most of our young professional clients, we recommend using a Roth IRA for three reasons:
Long-term Potential: Roth IRAs are considered “tax-free” because they are funded with contributions that have already been taxed. This means you could begin saving in a Roth IRA early, invest it for growth your entire career, and then at retirement take withdrawals without having to pay any taxes.
Limited Tax Savings from Traditional IRAs: For young teacher, the average retirement savings contribution starts small. So doing the math, the tax savings using a Traditional IRA today are minimal compared to the potential future benefit of the tax savings from a Roth IRA.
Emergency Flexibility: Unlike Traditional IRAs, Roth IRAs allow for tax-free, penalty-free withdrawals up to what was contributed to the account. So, if you’re still building your emergency fund at the bank but run into trouble, your Roth IRA could be tapped without taxes or penalties.
Many young teachers are able to do all of their retirement saving using a Roth IRA. Another strategy we recommend to our young professional clients adopt is using a combination approach. To do this they contribute enough to their employer plan to get the full match and then do the rest of their saving in their Roth IRA. In essence, they get the best of both worlds.
How much to save
Starting out, you should target 10% of your salary toward retirement savings, including any employer match. This means that if your employer will match 4% in your 401(k), you should be contributing 6%, so that together they hit the target of 10%.
I know this target seems high, especially if you’re just starting out, so if you can’t hit 10% right away, that’s okay. Do what you can and commit to increase your contribution to retirement savings 1% each year until you get there. Starting now will make a world of difference in the future.
Saving for retirement as a young teacher is different than at any other point in your life. It’s difficult, especially considering you’re probably making the lowest amount of money starting out that you ever will. However, right now there’s an opportunity that if seized can become the foundation for your successful financial future. Make sure you take advantage of it!
If you have any questions or would like assistance with your retirement savings we’re happy to help. Learn more at www.AnExceptionalLifeFinancial.com or get in touch at Info@AnExceptionalLifeFinancial.com
Mychal Eagleson, CFP®, AAMS® is the President of An Exceptional Life Financial, a firm that specializes in financial planning for teachers and families with special needs. He frequently writes and speaks regarding personal finance topics relating to these clients. Mychal also serves on the board of the Financial Planning Association of Greater Indiana as the Director of Public Relations & Social Media. To read more of his articles or learn about An Exceptional Life Financial please visit: www.anexceptionallifefinancial.com.