How to create your own retirement fund

Building a retirement fund, which we’ll define as saving enough money to pay bills when you’re no longer working, can seem like a daunting challenge. Taking a hands-on approach that focuses on what you can do today will help you take the challenge one step at a time.

Key points

  • Building a successful retirement plan is a long-term process that requires commitment and discipline.
  • Your primary goals should be to increase your income and reduce your debts.
  • It’s not enough to save money; you have to invest it wisely.

Pension fund theory versus reality

Regardless of your current age or income, the recipe for a successful retirement fund has a simple formula: Set a goal, commit, and repeat. One common approach encourages would-be investors to participate in their employer-sponsored retirement savings plan. Another suggests entering personal information into a retirement calculator to predict how much money you’ll need to fund your retirement.

While both ideas are great in theory, reality can quickly fall apart. Consider, for example, that approximately 31% of all private sector workers in the US lack access to retirement benefits, as of March 2022, as reported by the US Bureau of Labor Statistics. That, of course, leaves 69% who do, but only 75% of workers with access to a plan choose to participate in one, and only 52% of all American workers in private industry are saving in one.

Plus, the huge dollar amounts most people see when they use a retirement planning calculator can be daunting. A savings goal of a million dollars or more may seem unattainable for younger workers with low incomes, high debts, and nothing in the bank.

“Thinking in terms of the total amount of money you’ll need in retirement is daunting. But I think if you break it down into small steps, it’s a lot easier to digest,” says Shane P. Larson, CFP, senior associate financial planner for Mainspring Wealth Advisors, which has five offices in Washington state.

Given these realities, let’s start with a challenging scenario — one most of us find ourselves in early in our careers — and lay out a practical plan for building a retirement fund. In this scenario, let’s say you:

  • Not having an employer-sponsored savings plan and a high-paying job
  • You have a high debt burden from college loans, car payments, and rent or mortgage, plus living expenses

52%

The number of American workers in the private sector who are participating in a retirement plan as of March 2022.

Set a goal, commit, repeat

Several goals can be set in this scenario. The first is to start saving. Even if it’s only a few dollars a week, open a bank account and deposit the money. While a bank account isn’t the best investment vehicle in the world, it’s a great way to start making savings a habit. Remember, building a retirement fund is a long-term journey, and as they say, even a journey of a thousand miles begins with just one step.

Once you’ve established and committed to your savings goal, your next goals are clear: increase your income and reduce your debt. Achieving the first goal will help you achieve the second. To increase your income, you can take a second job or get a higher-paying job than you currently have.

The power of compound interest is critical to successful retirement planning.

While it may take time and effort to increase your income, it will help you stick to your plan if you keep in mind that it’s a long-term endeavor. Set a goal of getting a better job (or a second job), then make time to do a dedicated job search.

Once you reach your goal, your new income will allow you to reduce your debts. Then you’ll be able to shove more money into your retirement fund. Putting together a budget can help you with this process. It’s a great way to make sure your money is being used wisely. Remember that the earlier you start, the more time your savings have to grow through what experts call “the magic of compound interest.”

“The power of compound interest is the eighth wonder of the world. Having a long-term mindset with compound interest as your ally will enable you to turn a small steady savings rate into a comfortable retirement,” says Mark Hebner, founder and president of Index Fund Advisors, Inc. in Irvine, California, and author of “Index Funds: The 12-Step Recovery Program for Active Investors”.

Don’t just save, invest

Once you’ve increased your income and savings, you should have enough money saved up to swap your bank account for an Individual Retirement Account (IRA). At this stage, you are transitioning from saving money to investing money.

The Internal Revenue Service (IRS) sets the annual limit on how much a person can contribute to an IRA. For 2022, people under the age of 50 can contribute $6,000 to an IRA. If you’re over 50, you can add a $1,000 Recovery Grant for a total of $7,000 a year. For 2023, those numbers are $6,500 and $7,500, respectively.

You can of course start with a much smaller amount. An IRA is different from a regular investment account; you need to open one with a firm that handles IRAs.

If you don’t know much about investing, think of it as a way to put your money to work making you more money. From a practical point of view, you can start by putting your money in a mutual fund, as it is one of the easiest investment methods for beginners.

Simply choose an index fund that tracks a major US stock market index, such as the S&P 500, or an actively managed fund that invests in blue-chip stocks. To focus, set a goal to learn more about investing and work towards that goal.

Start by checking out Investopedia’s introduction to investing to round up the basics and reduce the terminology. Let the topics that capture your attention help you determine the next topic you would like to learn about.

Again, this is a long term effort. Don’t try to absorb it all at once. Just start reading, commit to doing it regularly, and stick with it. As you learn more, take the time to teach yourself about mutual fund fees, and make sure you don’t reduce your returns by paying more than necessary.

Get a 401(k)

Once you master the art of budgeting and start investing, you’ll probably want more money to raise both your standard of living and the amount you invest. Another job search can help you achieve these goals.

This time, look for a job that offers a 401(k) plan with an employer that matches your contributions. Invest enough to get the full company match. Over time, as you receive raises and promotions, increase your contribution rate up to the maximum amount allowed.

“Working for a company with a 401(k) is one thing. Working for a company that offers matching contributions is another. 401(k) matching is where you can really see your funds grow, and fast,” says David N. Waldrop, CFP, president of Bridgeview Capital Advisors, Inc., in El Dorado Hills, Calif.

The IRS has established annual contribution limits for 401(k)s. The maximum contribution for a 401(k) — as an employee — is $20,500 for 2022 ($22,500 for 2023). If you are over age 50, recovery contributions totaling $6,500 for 2022 ($7,500 for 2023) are also permitted.

For example, let’s say you earn $50,000 a year and your employer is willing to pay 5% of your salary as long as you also contribute a minimum of 5%. As a result, your minimum contribution would be $2,500 (5% of $50,000), and your employer would deposit $2,500 annually into your 401(k). Employer correspondence is free money.

Annual Matching has the potential to dramatically increase your savings rate because matching contributions are invested and the interest and earnings on that money are compounded over the years along with your contributions.

Can I set up my own pension fund?

Yes, you can create your own pension fund. One of the most common ways to do this is to open an Individual Retirement Account (IRA). IRAs come in two forms: a traditional IRA, funded with dollars before tax, and a Roth IRA, funded with dollars after tax. The annual contribution for both is $6,000 in 2022 and $6,500 in 2023, with a recovery contribution of $1,000 if you are 50 or older. Roth IRAs come with income limits, which determine if and how much you can contribute.

How do I create a retirement plan?

Creating a retirement plan starts with creating a budget. Knowing how much income you have and what your expenses are will help you understand your financial situation. The goal of this is to reduce debt and save money. The more you save, the more you can spend on retirement.

Once you save up the money, you can start contributing to retirement plans, such as Individual Retirement Accounts (IRAs). If your employer has a 401(K), you can contribute there as well, particularly if they match contributions. Other similar plans include 403(b)s, 457(s), and the Thrift Savings Plan. If you’re closer to retirement than at the start of your career, you’ll have a better idea of ​​how much money you’ll need in retirement and can start adjusting to that.

Can you build your own 401(k)?

If you don’t work for an employer, you can’t contribute to a traditional 401(k); however, if you are self-employed, you can build your own 401(k). For example, if you’re self-employed and have no employees, you can open just one 401(k) and contribute as both an employer and an employee.

The bottom line

Retirement planning is a long-term endeavor. Think of a marathon rather than a sprint. Most people will require a lifetime of effort to build a solid retirement fund.

“Preparing for retirement is more about persistence and less about brilliance,” says Craig L. Israelsen, Ph.D., investment portfolio designer at 7Twelve Portfolio in Springville, Utah. “When you think about preparing for retirement, think Crock-Pot, not the microwave.”

Engage in the effort and continue to improve your position by reducing your debts, improving your income, and increasing your education (among other activities). While the first few years will be a challenge, as the years go by, the progress you’ve made will become more apparent.

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