As you may remember from my previous columns, the place to begin is to be sure your income allows you to maintain your spending level. Create a budget so you know your expenses, and know where your money is going. Secondly, prepare for the unexpected by having the equivalent of about six months of basic living expenses available as emergency reserves. Next, take control of any debt you have, whether it is student loans, mortgages or credit cards.
Once you’ve taken care of the basics, you should begin saving money for your long-term life goals, such as retirement. I know you just graduated from college, but retirement is not as far into the future as you think. It also takes more money to retire than you think.
The first place you should start is your employer’s retirement plan(s). Most companies offer a 401(k), 403(b), SEP plan, SIMPLE plan, or other type of retirement plan. Employer-sponsored retirement plans have many benefits. Savings grow tax-deferred; contributions are generally pre-tax, so they lower your current income tax liability, and many employers offer a match on your contributions. For example, an employer may offer to “match” 50 percent of the first 6 percent you contribute to the plan. This means if you invest 6 percent of your salary into the retirement plan, your employer contributes or matches 3 percent. You are basically giving yourself a raise.
Once you contribute enough to your employer’s retirement plan to receive the match, you may want to consider establishing a Roth IRA, as your next place to save. The rules for Roth IRAs are one of the least complicated sets of rules that the IRS has established in some time. You must have earned income and be under the income limits. For 2013, these limits are 127,000 for single filers or $188,000 for married filing jointly. You can save $5,500 to a Roth IRA in 2013. Additionally, contributions grow tax-free, and income taxes will not be due on distributions from the Roth IRA, provided they meet a few criteria.
If you still have money in your budget to save, consider contributing the maximum allowed to your 401(k) plan. The maximum amount a person can contribute is set each year by the IRS. For the year 2013, employees can contribute up to $17,500, as an elective deferral to their employer’s 401(k) plan.
If you have maximized retirement plan contributions and made your Roth IRA contribution, but still have funds available to be invested, a regular brokerage account is the next best place for your savings. This is an account with no tax benefits, but also without any restrictions regarding when you can access the funds in it.
William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.