As you remain obsessed with your career progression or raising your kids, the precious days of your retirement planning eventually slip by. Amidst high inflation and increased cost of living, how do you plan to allocate funds for your retirement or your kids? How do you start investing for you kids?
An informed investor can strategize plans early on to ensure a worry-free retirement. As you juggle your priorities, you find it increasingly challenging to save for your retirement or even your kids after managing the ongoing living expenses. Well, you are not alone. Currently, around 55% of US citizens are lagging in their retirement savings.
Now, you might have heard financial experts touting ‘Start saving for your future as early as you can’ time and again. So, how exactly do you plan to allocate funds for your short-term goals, kids’ investments, and retirement goals?
We have chalked out a comprehensive guide on how to start investing to address all these financial priorities.
How much do you need to save for your retirement?
Well, that’s the million-dollar question. What would you consider to be your tentative lifespan? 70 something? 80 something? Or even the nineties? For how many years are you planning to save?
Considering that you don’t have an exact answer to this, you need to save for an unknown period, right? This is where you need the basic knowledge of generating recurring income from potential avenues. Besides, investment experts would advise you to invest in accounts generating compound interest. This way, you can be better poised to save for your retirement.
With the inflation rate reluctant to drop below the 6% mark, it’s logical to start saving for an expensive lifestyle. With strategic investments, you can prepare for rising costs in the coming decades.
Again, some ongoing expenses like childcare and mortgage might be lower as you near retirement. While calculating the expenses, it’s important to factor social security costs, rental income, and other expenses into your equation.
While you calculate your retirement savings, don’t overlook the following expenses.
- An average couple would need around $295,000 as medical expenses after their retirement.
- Factor in expenses like transportation, clothing, and food.
- Consider entertainment expenses such as movies, plays, or eating out.
- Consider travel expenses, stays at hotels, flights, and gas expenses if you drive
- Include the cost of life and health insurance policies
In the past, US citizens could comfortably retire with $1 million. However, with rising inflation and correspondingly higher living expenses, this amount is now inching toward the $2 million mark.
Best retirement plans to start saving for your future
Here are some of our top recommendations for you to start saving for your golden days.
1. Defined contribution plans
Defined contributions plans such as 401(k)s, and 403(b)s are currently the most popular workplace retirement schemes. If you are an employee, talk to your employer regarding these plans. Employees generally have individual accounts where they contribute to the organization’s plan. Typically, the amount is transferred by payroll deduction.
These plans have been around since the early 1980s. In 2019, more than 85% of the Fortune 500 companies offered defined contribution plans rather than other pension schemes.
Among various defined contribution plans, local and state governments usually choose the 457(b) plan. If you are aged below 50, you can contribute $22,500 annually to this plan. Individuals aged above 50 can contribute up to $30,000.
A Roth version like Roth 401(k) may also be available. Here, you can deposit your after-tax funds. On retirement, you can withdraw the amount tax-free. It’s logical to go for Roth only if you expect a higher tax rate during your retirement compared to the period when you contribute to the account.
2. IRA plans
The US government has developed a valuable retirement plan for its citizens. Workers can contribute a maximum of $6,500 to these accounts in 2023. The contribution limit for those aged above 50 is $7,500 per year.
American citizens can approach a financial institution like a brokerage firm or bank to set up an IRA. The IRA plans enable workers to save bonds, cash, mutual funds, and stocks for a secure retirement.
In general, you can choose from seven types of IRA plans. Depending on the plan you choose, the tax norms would differ. The common types of IRA plans include:
- Traditional IRA
- Spousal IRA
- Roth IRA
- SEP IRA
- Rollover IRA
- Simple IRA
3. Solo 401(k) plan
Solo 401(k) is a popular retirement account for business owners or self-employed professionals who operate without full-time employees. An individual or solo 401(k) plan provides benefits somewhat similar to a traditional 401(k) plan. However, you can find some differences between these plans. Alternatively, these plans also serve the retirement plans of business owners along with their spouses.
The employee contribution limit to your individual 401(k) plan is $22,500 in 2023. Individuals aged 50 and older enjoy a higher contribution limit of $27,000 and $30,000, respectively, which can be 100% of the total income they earn.
Given that self-employed professionals are both the employer and the employee, the contribution limit rounds up to $66,000. Individuals aged above 50 can contribute $73,500 a year. Most importantly, you can grow your retirement funds tax-free.
4. Guaranteed income annuities (GIAs)
Since your company is not likely to offer GIAs, it’s wise to create one of these for yourself. These annuities generate guaranteed income, replicating pensions. So, if you don’t have a regular pension scheme, it makes sense to go for GIAs.
As you approach your retirement, you can purchase an immediate annuity to generate a monthly payment consistently for the rest of your life. This would require you to shell out a lump sum amount. However, individuals prefer paying for these annuities over a period of time.
So, if you plan to retire at 65, start paying for your GIAs when you are 50. GIAs can be purchased on an after-tax system. So, the contributor will owe tax only on the earnings of these plans. Alternatively, there’s a provision for purchasing your GIA within an IRA to enjoy an upfront deduction of taxes. However, when you withdraw the funds, you must pay tax for the entire annuity.
5. The Federal Thrift Savings Plan
If you happen to be a government worker or serve the community as a part of the uniformed services, the Federal Thrift Savings Plan is worth considering.
You have five low-cost options of to start investing for your kids to choose from. These are:
- An international stock fund
- A small-cap fund
- An S&P 500 index fund
- A bond fund
- A fund investing in Treasury securities (specially issued)
Federal workers also have the privilege of picking from a number of lifecycle funds. These funds have different dates for target retirement investing in the core funds. As a result, you can make informed investment decisions.
Employers can contribute up to 5% to the Thrift Savings Plan.
Start Investing For Your Kids: The Best investment accounts
Now that you know where to save for your retirement, let’s explore the most practical strategies to save for your kids. Be it college fees or settling for a decent lifestyle upon reaching adulthood; it’s wise to keep the finances flowing.
Do you know that 53% of individuals banking on student loans regret taking this financial privilege from banks?
Your child has just a few options to invest as a minor. Being a responsible parent, it’s your discretion that defines the financial stability of your kid in the future. So, make sure to reap the benefits of compound interest by investing in your child when they are young enough. This way, they can avoid expensive education loans or getting into other financial liabilities.
Based on different criteria, we have shortlisted the best investment accounts for your kids.
1. Custodial Roth IRA
A Custodial Roth IRA account should be the first choice when you hunt for a child savings account without any age limit. Kids of any age can contribute to this account with their earned income. The contribution limit to this account is the child’s earned income, or $6,500, whichever is lower. Most importantly, your child can withdraw the contribution penalty without taxes at any age.
In general, Roth IRAs are individual accounts for retirement where you can use your after-tax dollars for contributions. While a minor can hold a custodial Roth IRA, the parents or guardian can manage these accounts.
However, there’s a catch: the income must be generated by your child. Children often earn money by providing tuition, house-sitting, or writing blogs.
If your child wants to withdraw both the earnings and contributions without paying taxes and penalties, they need to hold the custodial account for at least five years. Besides, they need to wait till the age of 59.5. Before retirement, they enjoy the privilege of drawing a maximum amount of $10,000 to manage expenses like buying a house.
2. 529 College Saving Plans
Parents looking for a child savings account to manage their educational expenses should explore the 529 College Saving Plans. There’s no limit to contributing; anyone can open these plans.
The savings accumulated in these plans can be used to manage educational expenses. This also includes repaying student loans up to $10,000 and managing apprenticeship programs. Based on your state, you may also be eligible for tax deferrals, tax benefits, deductions, and tax credits. 529 plans can be of two types.
- Prepaid tuition plans: This plan enables you to purchase college credits that your child can use in the future at the current prices.
- Education savings accounts: In this account, one can build a balance and channel the money for investment in the market, such as ETFs and mutual funds.
As long as you use the money for qualified educational purposes, you can withdraw the amount tax-free.
3. UGMA/UTMA Trust Accounts
Parents looking for more flexibility while managing their child’s savings accounts should go for UGMA/UTMA trust accounts. With these saving schemes, parents retain better control over how their children use the funds.
Parents also own the liberty to diversify the funds across asset classes such as mutual funds, stocks, or bonds. These investments help cover the increasing cost of education for your child in the future. Compared to other investment accounts for children, these accounts are easier to set up and manage.
UGMA/UTMA trust accounts don’t have specific contribution limits. However, individual contributions exceeding $17,000 per individual and $34,000 per married couple jointly filing per year invite federal gift tax.
Although contributors don’t enjoy any tax benefits initially, you can qualify for an exemption of $1,250 (maximum) on the earnings as the federal income tax. Besides, another $1,250 gets taxed at the rate applicable to the child.
Although the guardian or parent opens these accounts, the child can take them over at an age ranging between 18 and 25. One of the perks of these trust accounts over the 529 plans is that your child can use the money for expenses beyond education, such as marriage or purchasing a house.
4. Certificates of Deposit
CDs continue to be the safest investment option for those starting to invest for their kids, given that each account is insured up to $250,000 by the FDIC. Compared to traditional savings accounts, CDs yield more interest as your deposits undergo compounded growth.
The parent or guardian must open a custodial account with the minor child if they are under 18. However, CDs come with a maturity period, and withdrawing the amount early invites additional fees.
In case your child earns anything less than $1,250 through this account through dividends, interest, and other earnings, there’s no tax implication. The child’s tax rate would be applicable on earnings ranging between $1,250 and $2,500. Beyond this, the parent’s tax rate will be applicable on taxes.
Being a custodian of a CD, you can contribute a maximum amount of $15,000 to your kid without shelling out gift taxes.
Endnote
The secret to meticulous financial planning lies in being strategic while defining your immediate, mid-term, and long-term goals. As you start to invest for your kids, you’re a full on investor. Being an investor, you get the privilege to choose from a plethora of options, whether you wish to save for your retirement or your kids.
Each type of investment account also comes with its set of tax implications. A well-calculated approach to saving for your future as well as your kids warrants a worry-free retirement.
[Related: 6 Financial Investments to Set Up Your Child for Success]
