Entrepreneurs and small business owners tend to be very passionate about their work and don't often think about their retirement as much as they should. And I'm totally with these folks; fingers crossed, I'll be working up until they put me in the ground! But it's extremely important to prepare for the future in order to make working through your golden years a luxury - not an absolute must do.
This is a good reason to start building a great relationship with your 401(k) account.
You can make a few simple adjustments to your saving habits to make sure you're gaining the maximum benefits. Here's what the experts suggest:
1) Make regular contributions.
In a generational research report that came out recently, it was shown that Millennials had lower chances to contribute to their 401(k) plans, than their Baby Boomer and Generation X peers. Although retirement may seem something too distant to young people, by failing to keep up they miss the chance to benefit from compound interest early on.
For example, if you earn $40 thousand annually, make a 10 percent contribution to your 401(k) plan, your employer matches you for 3 percent, and earn a 6 percent annual return rate, starting at 22 would have you settled with more than $1 million by the time you reached 65. Conversely, waiting until the age of 30 to start saving, would only get you as much as $617 thousand. Starting early clears over $300 thousand extra in your nest egg, making a real difference in the quality of your retirement, or even the age you retire.
If 10 percent sounds too much, begin with smaller contributions and take advantage of your early start to progressively build your contribution rate every year. For example, start with 1 percent, then go for 2 percent the following year, and so forth. Although you probably won't even notice the difference in your paychecks, in a while you will be contributing more than you've ever thought possible. Furthermore, your 401(k) plan may be making these adjustments for you automatically, already. Actually, BenefitGuard reported that 50 percent of saving-rate increases of Millennials 401(k) plans were attributed to this type of "auto-adjustment."
2) Invest wisely.
As far as investing is concerned, UBS found in a study that Millennials were more likely to self-identify as conservative investors than their Baby Boomer or Generation X peers, even though they had the longest time window to retirement. As a matter of fact, a report by Bankrate.com revealed that almost 40 percent of people under 30 years old preferred cash for their investment of choice in money they won't need for at least the following decade. That was the most of any other age group and 300 percent higher than those who preferred stocks instead.
However, as ICI/EBRI reported, more than 65 percent of employees between 20 and 30 years of age had invested over 80 percent of their retirement account balance in equities. This is confusing because it's possible that a lot of Millennials may opt to withdraw from those equities during periods of market unrest, particularly if their lack of knowledge, conservatism, and distrust in the allocation of their assets render them too jumpy if they see losses in their account. Nevertheless, unloading stocks would actually convert a temporary virtual loss to a permanent real one. Moving money into cash will probably cause longer recovery times.
One way to counter this is to start simple: for example, a target-date retirement fund, serves this purpose, as you can set it and forget it, and it will automatically become more conservative the closer it gets to the target date. Your 401(k) provider might also have advice aids, like Schwab's Guided Choice and Financial Engines, which can give you more individualized advice at no added cost. Research has shown that investment aids like these boosted 401(k) returns by 2-3% annually on average. This can make an even bigger difference if the extra return is compounded over a longer time horizon until retirement.
Still, don't forget that even the best advice tool or fund option can keep you from liquefying your investments under panic. This is why you need to be financially educated. Check with your employer regarding the option to attend any unbiased financial guidance or education programs.
3) Don't cash out too fast.
We're not talking about cashing out your 401(k) plan to an early retirement (in which case, you should think about "substantially equal periodic payments" to steer away from the 10 percent early withdrawal penalty that is imposed when you retire before 55 years of age). On the contrary, Fidelity found that 41 percent of people aged 20 to 39 cashed out their plans right after leaving their job. How likely is it that they retired before 40?
This practice can lead to lost investment earnings and tax penalties. Part of it can be attributed to irresponsible spending or ignorance of the consequences, but much of it is fueled by actual need. As a matter of fact, in a study by the Georgetown University Center on Education and the Workforce, it was discovered that Millennials constitute 40 percent of the unemployed, as opposed to 37 percent from Generation X and 23 percent from the Baby Boomers. Our own research reveals that less than 50 percent of Millennials have invested in an emergency fund.
Before concentrating on your retirement savings, you should first work towards building a strong base of cash savings. A general rule of thumb is to have adequate funds for the necessary expenses of at least 3 to 6 months. This way, you will be able to spend your savings in a time of need without touching on your retirement funds.
You can choose to place those savings in a Roth IRA, which allows you to withdraw the contributions whenever you want, without added penalty or tax. If you cash out before the age of 59.5 years, you may be subject to penalties and taxes (exceptions apply, such as first-time house purchases and education expenses) but the contributions are the first to come out. What's great about this is that the funds you don't withdraw grow to be tax-free after five years, and you are over 59.5 years of age. You just need to make sure that your Roth IRA assets are kept somewhere safe (e.g. a bank or money market fund) until you have enough emergency savings built up somewhere else. When that happens, you are free to proceed to more aggressive investments of the Roth IRA, towards retirement.
See our Best Retirement Plans for Business.