Saving early for ave you started saving money for Workers also are saving too little. Experts retirement yet? It’s more important typically recommend that workers plan to save H than you may think—no matter your 8 to 11 times their annual income for retire- age. ment. But according to the National Institute Saving early for retirement is the best on Retirement , 4 out of 5 working way to maintain financial independence households had saved an amount less than and security later in life. “Regardless of the their annual income by 2010. Even when amount you save, you will definitely be in a the value of other , such as a home, is better situation if you start early than if you included, two-thirds of households approach- wait until your mid-30s or 40s,” says Jack ing retirement had not saved enough. VanDerhei, research director of the Employee Especially for workers just starting their Benefits Research Institute. “The longer you careers, the message is clear: start saving now, wait, the more you will have to save—until it no matter how far in the future retirement becomes too great a burden.” seems. “Learn from those who are retir- ing today,” says Denise Appleby, owner of a But many workers lack access to a retirement consulting . “Otherwise, retirement plan or decline to take part in you might regret not saving enough, early one. According to the U.S. Bureau of Labor enough.” Statistics (BLS), less than one-third of non- This article provides an overview of dif- federal workers had access to a defined-benefit ferent ways to start saving early for retirement. plan, better known as a , in March The first section describes retirement plans 2012. And although about half of workers had and options. The second section access to a defined-contribution plan, such explains how to choose a plan and invest- as a 401(k), only 68 percent of them saved in ments. The third section discusses ways to one. (See table 1.) save more. Resources for more information Often, workers wait too long to start are listed at the end of the article. thinking about saving for retirement. Accord- Dennis Vilorio ing to the Center for Retirement Research at Boston College, of workers in 2010 who were Exploring savings options eligible to participate in a 401(k) plan, 60 per- Before you begin saving for retirement, you cent contributed to it when they were in their need to understand your options for retirement 20s, compared with 84 percent in their 50s. plans and the found within them. The information in this section provides the Table 1: Retirement benefits for all basics you need. civilian workers1, March 2012 Retirement plans 2 Retirement benefit Access Take-up rate One of the best ways to prepare for retirement Dennis Vilorio is 3 is with a retirement savings plan. There are All retirement benefits 68% 79% an economist in three main types of retirement plans: defined- Defined benefit 29 91 benefit plans, defined-contribution plans, and the Office of Oc- Defined contribution 55 68 Individual Retirement Accounts (better known cupational Statis- tics and Employ- 1 Includes workers in the private nonfarm economy as IRAs). except those in private households, and workers in Employers may offer one, both, or neither ment Projections, the public sector, except federal government. of the first two plans as part of your benefits BLS. He can be 2 The take-up rate is an estimate of the percentage of workers with access to a plan who participate in package. On your own, you also can save in reached at (202) the plan, rounded for presentation. an IRA to complement the other plans or as 691-5711 or at 3 Includes defined-benefit pension plans and defined- your main retirement savings plan. contribution retirement plans. vilorio.dennis@ Source: U.S. Bureau of Labor Statistics, For many workers, one plan alone may not bls.gov. National Compensation Survey be enough. Workers with some combination of

www.bls.gov/ooq • Fall 2013 15 the three plans are likely to have better finan- incentive, many employers match contribu- cial prospects in retirement than those with a tions up to a certain percentage of the employ- single plan. ee’s . Defined-benefit (pension) plan. In a As of 2013, employees can save up to defined-benefit plan, more commonly known $17,500 per year in a defined-contribution as a pension, employers put aside money for plan. These savings are taxed, but the money each eligible employee and invest it on his gained from growth is not. Employees must or her behalf. The employer guarantees a pay taxes, either when they withdraw or when monthly benefit when the employee retires they contribute, depending on the type of based on a number of factors, such as defined-contribution plan: Traditional or Roth, and length of service. respectively. But becoming eligible for a pension usually means you must remain with one In a traditional plan, employees pay employer for a long time. Furthermore, to cut taxes on contributions when withdrawing the costs, many employers have either reduced money. Employees who choose a Roth plan— pension benefits or switched to defined-contri- named after its legislative sponsor, the late bution plans. Delaware Senator William Roth—pay taxes Defined-contribution plans. In a defined- upfront but withdraw their money tax-free. contribution plan, the employees—not the Employers who offer a Roth plan typically employers—make most of the decisions. also offer a traditional plan. Employees set aside money for retirement Depending on who uses them, defined- directly from their paychecks, select and contribution plans are more commonly known manage investments, and choose how much by other names that represent the section or and when to withdraw money in retirement. subsection of tax laws under which they are Employees also accept the risk of losing identified. They are known as 401(k) plans money. for the private sector, 403(b) plans for schools But employers still help in other ways. and nonprofit organizations, and 457 plans Employers administer the plans and choose for state and municipal government. Thrift investment options, for example. And, as an Savings Plans for the federal government are

Many employers sponsor retirement plans to help employees begin saving for retirement from their first day on the job.

16 Occupational Outlook Quarterly • Fall 2013 administered by the Federal Retirement Thrift experts typically recommend investing in Investment Board. mutual funds. The most common defined-contribution Mutual funds pool money from many plan is the 401(k) plan. This term is often people and institutions to buy financial assets. used, including in this article, to represent all There are four types of mutual funds: Index, defined-contribution plans. exchange-traded, target-date, and actively IRAs. An IRA is a retirement plan that managed funds. These funds are further clas- employees open and manage on their own— sified by type, usually or bonds. usually without help from an employer. As The value of is known as equity. in a defined-contribution plan, with an IRA When you buy shares of an equity fund, employees must select investments, decide you become part-owner of a number of com- how much money to deposit and when to panies. When you buy shares of a fund, withdraw it, and accept the risk of losing you lend money to a number of companies or money. Savings are also taxed, but the amount governments. You can also select funds that they earn from growth is not. And there are invest in domestic or international assets. traditional and Roth versions with the same Mutual funds have annual management tax benefits as described above. fees, called the ratio. These fees vary But the similarities between IRAs and by the fund’s provider and type. (See table 2.) employered-sponsored plans end there. Index funds. Index funds are a simple, Compared with employer-sponsored plans, inexpensive way to invest in a financial traditional and Roth IRAs have lower contri- market. An index fund replicates a market bution limits, up to $5,500 per year in 2013. index—which tracks the total value of assets IRAs also have more flexible withdrawal in a financial market over time—by holding rules, making it easier to access retirement financial assets in the same proportion. For savings for emergencies and big . example, if a stock makes up 5 percent of a And, depending on the type of IRA, there are market, the index fund would hold enough of some eligibility restrictions, such as income that stock to make up 5 percent of the fund. and age. At the end of each business day, index There are other IRAs meant specifically funds automatically adjust to changes in the for the self-employed and small . market indexes. For example, if a company’s These IRAs, called simplified employee pen- stock grew relative to the market, the index sion (SEP) and savings incentive match plan fund buys more to match the stock’s new pro- for employees (SIMPLE) IRAs, are similar to portion in the market index. traditional IRAs but have higher contribution Exchange-traded funds. Most exchange- limits. traded funds, more commonly known as In a SEP IRA, self-employed workers ETFs, are similar to index funds. ETFs track a and small-business owners can contribute up to 25 percent of income or $50,000 per year, Table 2: Average expense ratio (fees) whichever is less. In a SIMPLE IRA, small by type of mutual fund, 2012 businesses must contribute 2 percent of the employee’s salary or match up to 3 percent Type of mutual fund Expense ratio of salary if the employee also contributes. Employees can contribute up to $12,000 per Index bond 0.12% year. Index equity (stock) 0.13 Target-date 0.58 Investment options Actively managed bond 0.65 After setting up a 401(k) or an IRA, you Actively managed equity 0.92 need to select where to invest your savings. Although you can invest in almost anything, Source: Investment Company Institute

www.bls.gov/ooq • Fall 2013 17 market index, automatically adjust to changes, available, opening a SEP IRA when self- and have low fees. employed, and opening IRAs with mutual But unlike index funds, ETFs adjust to fund companies. market changes throughout the day. This Choose a Roth plan, when available. makes ETFs easier to trade quickly but often According to experts, workers just starting also more expensive. For retirement purposes, their careers benefit most from owning a Roth experts typically recommend index funds plan, such as a Roth IRA or Roth 401(k). over ETFs, which are usually better suited for With a Roth plan, young workers pay people who trade often. taxes on retirement savings at the time of Target-date funds. Target-date funds investment, when their incomes and tax rates bundle a diverse set of domestic and inter- are likely to be low, and withdraw the money national mutual funds, usually index funds. tax-free at retirement. Another advantage to Target-date funds hold each component fund Roth plans is that current tax rates are near in a predetermined proportion, called the asset historic lows. allocation. They also adjust daily to changes But not all workers have access to a in the markets and annually to keep your sav- Roth 401(k) plan. If your employer offers a ings on track as you age. traditional 401(k) plan, or no plan at all, you Target-date funds are sometimes known still have another Roth option. After sav- as lifecycle or age-based funds. ing enough in a traditional plan to get your Actively managed funds. Actively man- employer’s full matching contribution, for aged funds try to outperform the market example, you can save in a Roth IRA to guard index. A manager chooses assets based on a against rising tax rates. variety of factors, such as advanced metrics, Self-employed? Open a SEP IRA. If specific investing strategies, and personal you’re self-employed or own a small business, preferences. experts recommend that you open a Simpli- The fund’s fees include payment to the fied Employee Pension (SEP) IRA. With a manager for administering the fund. As a SEP IRA, you can save up to nine times more result, actively managed funds are more money than with a traditional or Roth IRA. expensive than index funds. And having a SEP IRA doesn’t rule out having a Roth IRA. Because you make SEP IRA contributions as an employer, opening Choosing a plan and a Roth IRA could provide another source of retirement savings. investments Open IRAs with a mutual fund Choosing among all the options for retirement company. Because mutual fund companies saving can be confusing. You might not know typically offer the best investment options at which retirement plan to choose or how to the best price, experts recommend opening sort through the many different investment an IRA there. But these companies have strict options available in each plan. If you feel conditions, which often include requiring overwhelmed, financial professionals can you to automate contributions, keep a mini- assist. mum balance, and invest a minimum amount You don’t have to be a financial expert to (often between $1,000 and $3,000). Some save for retirement. The information in this companies reduce the minimum investment section can help you narrow your options. requirement if you agree to make a minimum monthly contribution. Which retirement plan? Another option is to open an IRA at a dis- Before you begin saving for retirement, you count brokerage. Brokerages, which have few first need to open a retirement plan. Experts or no requirements, make investment easier recommend choosing a Roth plan when if you can’t afford the minimum required by

18 Occupational Outlook Quarterly • Fall 2013 mutual fund companies. But discount broker- perform in the future,” says Anthony Webb, ages charge a transaction fee, usually between a senior research economist at the Center for $5 and $15, which can apply each time you Retirement Research. contribute to or change your investments. Instead, they say, look at the fees or expense ratio. “Fees seem small but, over Understanding mutual funds time, they really eat into your savings,” says Once you have a retirement plan, you must Angela Hung, director of the RAND Center decide where to invest your money. Experts for Financial and Economic Decision Making. recommend choosing target-date funds, opting Unlike a fund’s future performance, you can for funds with low fees, and avoiding expen- control how much you pay in fees. Choosing sive actively managed funds. funds with low fees allows you to keep more Confused? Choose a target-date fund. of your money. (See table 3.) If you’re uncomfortable investing on your Avoid actively managed funds. In a given own, experts recommend that you choose the year, some actively managed funds perform target-date fund that most closely matches the better than the market. But investors usually age or year when you plan to retire. come out ahead with index funds, which have Target-date funds are available in many lower fees. That’s especially true over the long retirement plans. If your plan doesn’t offer term, say experts, which is what you need to them, you can invest in a few index funds to consider when saving for retirement. “There’s replicate a target-date fund’s asset allocation no evidence that actively managed funds for your age. This tactic requires periodic outperform index funds,” says Webb. “What adjustments to follow the target-date fund you’re doing is transferring money from your as you age and as the markets change. For pockets to those of the fund manager.” example, some experts recommend adjusting Because the long-term performance of every month or when an asset’s desired alloca- actively managed funds rarely justifies higher tion changes by 5 percent or more. fees, say experts, it’s best to avoid them when Choose funds with low fees. When saving for retirement. presented with an overwhelming number of investment options in a retirement plan, you might be tempted to look only at funds that Consult a professional have recently done well. Experts caution A financial professional can create a custom- against doing that. “A fund’s past performance ized plan for your financial goals, including tells you next to nothing about how it will retirement. Seek out professionals who charge

Table 3: Net value over 30 years for two average equity funds with an initial investment of $10,000 and a 10-percent annual return

Index fund Actively managed fund Years later Difference (0.13-percent expense ratio) (0.92-percent expense ratio) 1 $10,987 $10,908 $79 5 16,010 15,443 567 10 25,633 23,848 1,785 15 41,038 36,828 4,210 20 65,703 56,873 8,830 30 168,412 135,629 32,783

Source: Expense ratio calculator at the Central Provident Fund Board (www.cpf.gov.sg/cpf_trans/ssl/financial_model/expense_cal2.asp)

www.bls.gov/ooq • Fall 2013 19 a flat fee and are legally required to serve in and save. Learning about , your financial , called a fiduciary duty. limiting expenses, avoiding high-interest , Currently, only registered investment and building an emergency fund are four ways advisors have a legally mandated fiduciary to build a solid savings foundation. duty. Other financial professionals have a Learn personal finance. By learning voluntary or unclear fiduciary duty. Financial personal finance, you discover how to manage professionals who do not have a legal fiduciary your money and control your expenses. Free duty may have conflicts of interest, such as personal finance lessons are available online; recommending an investment for commission. some schools and libraries offer courses. Top- If you’re unsure about investing for retirement, ics covered usually include budgeting, saving, you may prefer to hire a registered advisor. and debt management. But hiring a financial professional is Limit expenses. Everyday living expenses an expense you may not want. If you find a add up quickly. Limiting these expenses frees target-date fund that meets your investment up money you can save for retirement. “Unfor- needs, you may not have to consult a profes- tunately, a dollar can only be spent once,” says sional. Webb. “If you want to save more, you’ll need to spend less.” Discretionary spending is usually the Saving more easiest place to start. This includes optional Saving for retirement requires planning. Take expenses, such as dining out or traveling for charge of your personal finances and how vacation. To save even more, limit how much you contribute to retirement so you can save and how often you spend money on things you more—regardless of your financial circum- want but don’t need. stances. Avoid high-interest debt. Carry- ing balances on high-interest debt, such as Managing finances cards and payday , can hurt your Managing your personal finances, especially finances. Mounting debt from the combina- early in your work life, helps you plan ahead tion of high interest rates and penalty fees

Learning personal finance can help you limit discretionary spending so you can save more for retirement.

20 Occupational Outlook Quarterly • Fall 2013 may become overwhelming. By living within VanDerhei. “Otherwise, you’re just leaving your means and paying your bill free money on the table.” in full each month, you’ll stay out of financial Automate. For some workers, the biggest trouble. obstacle to saving for retirement is setting up If you already have high-interest debt, a plan. To help employees overcome this dif- focus on paying it off. The reason, say experts, ficulty, many employers automatically enroll is that the amount this debt costs you is them in a retirement plan. unlikely to balance out against future retire- Once employees have a retirement plan in ment gains. “Credit card debt can easily come place, they’re likely to carry on with con- with an interest rate of 12 to 15 percent,” tributing. “Automatic enrollment and con- Webb says. “There’s no investment in your tributions have powerful effects on people’s retirement plan that can consistently offer that saving behavior,” says Hung. And people who rate of return.” contribute automatically from their paychecks Build an emergency fund. An emer- usually save more, because they never see the gency fund is an adequate amount of money money to spend it; instead, it goes directly reserved for unplanned expenses, such as into their retirement fund. costs incurred from an accident, illness, or Stick to your plan. Misguided emotion job loss. Having an emergency fund can mean can lead to investment mistakes, caution the difference between a setback and financial experts. “Don’t let your emotions guide what disaster. The money should be kept safe and you do,” says Chuck Yanikoski, president of a easily accessible; for ideas on where to keep software company. “You your emergency fund, see the box on page 22. might invest in something you don’t under- Experts typically recommend an emer- stand or buy and sell at the wrong time.” gency fund equal to about 3 to 6 months of Creating a plan, and sticking with it, helps your wages, depending on your risk of job you avoid emotion-driven pitfalls. One of the loss. advantages of target-date funds, for example, is that they follow predetermined investing Managing contributions strategies. By minimizing mistakes, you can Managing your contributions well can get more out of your retirement savings. improve how you save for retirement and Don’t withdraw early. Most retirement increase current savings. Strategies include plans have a tax penalty, usually 10 percent, taking an employer’s matching contribution, for withdrawing money before age 59½. The automating contributions, sticking to your purpose of the penalty is to encourage invest- plan, not withdrawing money early, and rein- ment until retirement age. vesting when changing jobs. If you need money from the plan before Take the employer’s match. Your you’re eligible to withdraw it, there are ways employer’s matching contribution to your to avoid the penalty. Withdrawal exceptions retirement plan could double how much you for defined-contribution plans, such as a save for retirement. For example, if your 401(k), are typically stricter than those for employer matches contributions up to 5 per- IRAs. For example, 401(k) plans may allow cent of your wages, you bump your savings withdrawal only in situations involving dis- rate to 10 percent by taking part. Half would ability or financial hardship. By comparison, come from your contributions and the other Roth IRAs offer more flexibility: after 5 years, half from your employer’s match. you may withdraw penalty-free to help pay for Experts say that participating in the expenses such as a first home, college, or large matching option makes good financial sense. medical bills. “Whenever possible, you should contribute the maximum your employer will match,” says (Continued on page 23)

www.bls.gov/ooq • Fall 2013 21 Short-term savings options Saving early for retirement isn’t possible for account. High-yield accounts, money everyone. Some people have more immediate market accounts, and Series I Savings Bonds financial goals, such as saving for an emer- (I Bonds) keep your money safe and acces- gency fund. Others prefer to pay off debt, such sible in the short term until you’re able to save as student loans or credit cards. for retirement. Experts say that temporarily putting off High-yield bank accounts. Some finan- retirement savings is OK. “Thinking early cial institutions, especially credit unions and about retirement is good, but saving for online , offer checking and savings retirement is a personal decision,” says Chuck account options that have high interest rates. Yanikoski, president of a retirement planning These high-yield accounts require you to meet software company. certain monthly conditions, such as setting up If you decide to delay retirement savings direct deposit, using your debit card a number for other priorities, you still have short-term of times, and receiving account statements options for stashing your money that offer online. better returns than a low-interest savings Along with high-interest yields, banks may offer other rewards, such as ATM fee refunds, for meeting their conditions. Many banks offer Money market accounts. Money market high-yield and money accounts, available at most banks, usually market accounts with offer higher interest rates than a traditional savings account in exchange for keeping a higher interest rates in high minimum balance—ranging from $500 exchange for meeting to $25,000. As in high-yield bank accounts, certain conditions. your savings are insured and accessible by using an ATM. Many money market accounts limit the number of transactions you can make each month, however. I Bonds. I Bonds use a composite interest rate, which combines a fixed rate and an infla- tion rate to ensure that your savings maintain their purchasing power. Until October 31, 2013, the composite rate for new I Bonds is 1.18 percent. The federal government adjusts the rate semiannually and guarantees your money. For up to 30 years, I Bonds earn the inter- est rate set at the time of purchase. You can cash them in after 1 year, but you lose the last 3 months of interest. After 5 years, there is no penalty. If the composite rate for new I Bonds rises significantly, you might benefit from cashing out early and buying again at the new rate. I Bonds are most useful when saving for expenses a few years into the future, such as a downpayment for a home. You also can use them to store some of your emergency fund.

22 Occupational Outlook Quarterly • Fall 2013 (Continued from page 21)

Even if you can withdraw penalty-free, however, experts recommend against it. Instead, they advise, tap into retirement sav- ings only when absolutely necessary. Reinvest when changing jobs. When you change jobs, you have the option of withdraw- ing your 401(k) savings, but you will pay penalties in the process. However, you also Call toll free, 1 (800) 732-0330, or visit online have the option of rolling over, or reinvesting, at www.investor.gov. A guide to mutual funds the balance penalty-free into an IRA. is available at www.sec.gov/investor/pubs/ Still another option is to leave your money sec-guide-to-mutual-funds.pdf. where it is and start another plan with your To learn more about why saving early new employer. This may be an attractive helps you save more, try the interactive sav- choice if your existing retirement plan offers ings calculator at www.econedlink.org/ good investment options with low fees. For interactives/EconEdLink-interactive-tool- example, experts advise that workers who player.php?filename=interest.swf&lid=603. leave the federal government should keep their This tool shows the effects of compound inter- savings in the Thrift Savings Plan. est on your savings over time. For more information about retirement data and research, contact: For more information Center for Retirement Research at There is a wealth of retirement information Boston College available, although no single source provides 258 Hammond St. comprehensive information concerning all Chestnut Hill, MA 02467 aspects of retirement. You can continue your (617) 552-1762 research by exploring some of the resources http://crr.bc.edu suggested in this section. [email protected] The U.S. Department of Labor hosts a website with general information about retire- Employee Benefit Research Institute ment for both employees and employers. Visit 1100 13th St. NW., Suite 878 www.savingmatters.dol.gov. Washington, DC 20005 The April 23, 2013, episode of the Public (202) 659-0670 Broadcasting Service news show Frontline www.ebri.org studied the current state of retirement sav- [email protected] ings. Topics include the shift from to contribution plans and advice about getting Investment Company Institute the most from your retirement dollars. Watch 1401 H St. NW., Suite 1200 at www.pbs.org/wgbh/pages/frontline/ Washington, DC 20005 retirement-gamble. (202) 326-5800 For more information about federal tax www.ici.org rules and incentives for retirement, visit the Internal Revenue Service’s resource at National Institute on Retirement Security www.irs.gov/Retirement-Plans. 1612 K St. NW., Suite 500 The U.S. Securities and Exchange Com- Washington, DC 20006 mission offers detailed information about (202) 457-8190 investing. Topics include investment products, www.nirsonline.org guiding principles, and tips for avoiding fraud. [email protected]

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