If you haven’t started putting away money for your nest egg yet, you’re not alone. According to a 2014 report from the Employee Benefit Research Institute, nearly 40% of workers have less than $1,000 saved for retirement.
Getting your savings plan on track can seem daunting, especially if you can’t afford to set aside a lot of cash at once.
Before you’re tempted to just forget about saving at all, you shouldn’t underestimate the power of small steps. Even if $100 a month is all you’re able to save, you might be surprised at how it adds up in the long run if you know where to put it.
Start with your employer’s retirement plan
If you’re eligible to participate in a 401(k) at work you’re essentially passing up the chance to score some free money if you’re not contributing to the plan. Most employers offer a company match on every dollar you save, up to a certain amount. For example, if your employer matches 50 cents for each dollar you put in, contributing $100 a month would add up to an extra $600 in savings annually.
Running the numbers can give you an idea of just how that seemingly small amount is worth. If you start saving $100 a month at the age of 35 and you keep saving that amount for the next 30 years, you’d have around $250,000 assuming a 7% rate of growth. If your employer matches 50 percent of your contributions, your balance swells to nearly $360,000. Not too shabby for what’s roughly the equivalent of a couple of lunches out each week.
Aside from cashing in on the employer match, you’re also generating some tax benefits by saving in your 401(k). If you have your $100 monthly contribution deducted directly from your pre-tax earnings, you’re effectively reducing the amount of your income that’s subject to tax. Depending on what tax bracket you normally fall into and how your deductions add up, deferring that little bit of money each month could reduce your tax bill or result in a larger refund.
Open an IRA
If your employer doesn’t offer a retirement plan, that doesn’t mean you don’t have any options for saving. An Individual Retirement Account or IRA can fill the gap and you’ll still be able to take advantage of some tax breaks.
A traditional IRA offers the tax benefit up front, in the form of a deduction when you file. As long as you (and your spouse if you’re married) are not covered by a plan at work, you can deduct the full amount you save, regardless of how much money you make. If you’re married but your spouse is covered by an employer’s plan, the full deduction is phased out when your combined gross adjusted income hits $183,000.
For 2015, savers could contribute up to $5,500 to this type of IRA or $6,500 if you’re over age 50. The same annual contribution limits apply to a Roth IRA but you don’t get the tax deduction, since these accounts are funded with after-tax dollars. The advantage is that when you’re ready to retire, your withdrawals are tax-free. With a traditional IRA, your distributions are taxed at your regular rate.
Whether or not you can contribute to a Roth IRA depends on your income and filing status. If you’re single, you can save up to the maximum for 2015 as long as your gross adjusted income is under $116,000. If you’re married and file a joint return, the income limit is bumped up to $183,000. If your status is married filing separately, you can contribute a reduced amount as long as you made less than $10,000 during the year.
In terms of how far $100 a month goes when you’re saving in a traditional or Roth IRA, you’d see your money grow to about $121,000 if you saved for 30 years. While that’s much less than what you’d get if you were putting the money in a 401(k), it’s still nothing to sneeze at.
IRA or IRA CD?
If you’re not well-versed in what your different retirement savings options are, you may not know that there’s a difference between an IRA and an IRA CD. With an IRA CD, you’re still getting the same tax benefits as you would with a traditional or Roth account but you also have the features of a certificate of deposit.
IRA CDs offer the least amount of risk so if you’re worried about losing money in the market, these kinds of retirement accounts are a safe alternative. The downside is that because you’re assuming a much lower level of risk, you’re also passing up the chance to see some bigger rewards in terms of how much your money is able to grow.
Most banks and brokerages offer IRA CDs, with terms that can extend over a period of months or years. One of the nice things about an IRA CD is that you can usually fund one with as little as $100 to start and many of them are structured so that you can continue adding money each month.
With some brokerages, on the other hand, you’ll find that the minimum to open an IRA is much higher. Vanguard, for instance, requires at least $1,000 to set up a new account and you’ll need at least $3,000 to invest in the majority of its mutual fund offerings. That’s not an overwhelming amount of money but it can be a major barrier when you’re saving for retirement on a shoestring.
Invest through your insurance plan
A Health Savings Account can double as a retirement savings account if you don’t have any other options. These accounts are only available if you have a high deductible health insurance plan but if you’re not using yours, you could be overlooking a valuable way to save.
For 2015, you could add $3,350 to an HSA if you’ve got individual coverage or $6,550 if you’ve got a family plan. Any money you put in is tax-deductible and you won’t pay any taxes on withdrawals that are used to cover qualified health care expenses. If you pull money out before age 65 to pay for non-medical expenses, you’ll pay a 20% tax penalty on the money. If you leave it alone until after your 65th birthday, the tax penalty no longer applies.
An HSA is a good choice if you only have a little money to invest towards retirement and you’re in good health. If your employer offers matching contributions, you could even reduce what you’re putting into your account and put the difference in your 401(k) or IRA to double up on the savings.