Starting the year off right isn’t about short term resolutions or quick fixes...it’s about creating responsible, financial habits to set you up for long term success.
When it comes to finance, we have a lot of Qs. And our friends at Vanguard have a lot of As. Vanguard Investment Analyst Kelly McShane answered some of the biggest questions from Skimm’bassadors to help us all start 2019 off right and stay on track to create smart financial habits.
1. What is the difference between a 403(b), 401(k), Roth IRA, etc? How can we be the most savvy about saving for retirement early on?
When it comes to saving for retirement, there are several different account types that each come with distinct differences, therefore understanding the retirement savings plans that may be available to you is a good place to start. Broadly, there are two ways to save for retirement. The first is saving through employer-sponsored retirement plans, which would include plans such as a 401(k) or a 403(b), and the second is through individual retirement accounts, or IRAs
Employer-sponsored retirement savings plans are tax-advantaged savings plans that are offered by an individual’s employer. There are several types of employer-sponsored plans, including defined-benefit plans (aka pensions) and defined-contribution plans (aka 401(k), 403(b), etc.) In defined-contribution plans, you (the employee) contribute a certain amount from each paycheck into an individual account within the employer plan. Additionally, some employers offer an employer-match, which means that for every dollar you contribute, your employer could possibly contribute the same amount up to a certain percent (aka essentially free money!). This can provide a huge benefit when it comes to saving for retirement by allowing you to save more than you may be able to save on your own. Another important characteristic of defined-contribution plans is that the employee chooses how to invest their contributions by selecting from the options provided by the employer, and the employee also bears the investment risk. Overall, 401(k) and 403(b) plans are relatively similar, however the one key difference is the type of employer who generally provides these plans to employees. 401(k) plans are usually provided by a for-profit employer, and 403(b) plans are usually provided by a not-for-profit employer.
Similar to employer-sponsored defined contribution plans, individual retirement savings accounts (IRAs), are also tax-advantaged savings accounts that are intended to encourage retirement savings, however these accounts are established and managed completely by the individual and are separate from the employer. The two main types of IRAs are Roth IRAs and traditional IRAs. And the key difference is the tax treatment of these accounts. Contributions to a Roth IRA are made using after-tax dollars, which means withdrawals in retirement are tax-free. Contributions to a traditional IRA are made using pre-tax dollars, which means that withdrawals in retirement are taxable. The most appropriate IRA for you will depend on your personal tax situation. Whichever way you choose, saving for retirement using an IRA is a great option for both those who don’t have access to an employer plan, or those who want to save in addition to their employer plan.
The best way to save for retirement is to start as early as possible, and save as much as you can. In general, we recommend saving 12-15% each year for retirement, but it’s okay to start small and build up to this amount overtime. A good place to start is by saving in an employer plan, at least up to the employer match, if available. This match provides a 100% on your investment, and you don’t want to leave that money on the table. From there, you can determine whether to increase your savings in your employer plan, or establishing savings in another tax-advantaged retirement savings account such as an IRA.
2. How should we manage old 401(k) plans (from prior jobs), when should one roll them over or start a IRA? Is there an easy way to find any and all accounts we have?
In terms of managing old employer-sponsored plans, the best approach will depend on your personal situation. Leaving your 401(k) invested “as-is” is an option, however there are several benefits to rolling over your 401(k) into an IRA.
First, it’s important to keep in mind that having all of your accounts in one place can be an effective way to ensure you are staying on top of your financial goals. Therefore, if you have other retirement savings or accounts elsewhere, it can be a good idea to consider rolling your 401(k) over into an IRA with your chosen provider. Second, in addition to allowing you to see your entire retirement savings picture in one place, rolling over into an IRA can provide other important benefits. These include keeping your retirement savings in a tax-advantaged account, and providing more flexibility to select from a wider range of investments than most employer-sponsored plans typically offer. Other factors that should be considered when choosing whether to roll over or leave your money in an employer retirement plan include fees and expenses, available services, potential withdrawal penalties, protection from creditors and legal judgements and required minimum distributions. If a rollover is right for you, the best time to initiate it will depend on your unique circumstances and priorities. However, in order to take advantage of these key benefits, you may want to explore this option sooner rather than later.
When it comes to locating any and all accounts you may have, the good news is that because companies are required to mail any abandoned funds to the account owner’s last known address, and turn over any unclaimed funds to the state, this process can be relatively straightforward. Using online resources, like those provided by the National Association of Unclaimed Property Administrators, is a good place to start!
3. Should I pay off my non-revolving debt (car loan, mortgage, student loan etc) before investing (beyond my 401(k))? How and when should I start paying off my student loan debt?
We recommend establishing retirement savings first, and at least up to the employer match if available. The earlier you start saving for retirement, the less you’ll have to save in the future, so it’s important to start as soon as possible. From there, you can determine a strategy for paying off debt. A good place to start is by looking at the type of debt and the associated interest rates. Paying off debt with higher interest rates and payments that are not tax-deductible, such as credit cards and auto loans, should be prioritized first. For debt with lower interest rates and/or payments that are tax-deductible, such as student loans or mortgages, you can consider paying the minimum and investing the difference. Overall, the best strategy will depend on your personal situation.
4. What are some of the best practices for merging finances when getting married?
When getting married, the best way to merge your finances will depend on you and your partner’s personal situation and preferences, so start with an open and honest dialogue about finances to determine the best approach. Individuals have different spending habits, income levels, and views about money, therefore conversation is key. From there, you can determine the best method for you and your partner. There are many ways to approach this, but there are two common methods used to merge and manage finances as a couple:
Completely combined finances – “What’s mine is yours”
All income, saving, and spending is combined and joint accounts are used for everything. This is the simplest way to combine finances, however it requires an ongoing and open dialogue about finances in order to ensure both partners are on the same page. Setting a spending threshold for large purchases can be helpful, and reviewing financial statements and goals together every 6 -12 months is also a good idea.
Some individuals, especially for those who are newly combining finances, prefer to still keep a portion of finances separate. In this method, the majority of each partner’s income would be placed into a joint account, and this account is used for the bulk of the couple’s spending and saving. Then, the remaining portion would be kept in an individual account for each partner. This individual account is used for spending on smaller purchases for themselves (e.g. coffees, shoes, etc.) or for gifts and surprises for their partner.
The exact amount placed into the joint account vs the individual account will depend on the couple’s personal situation. A common starting point is to put 80% of income into joint account and 20% of income into an individual account. From there, the couple can determine whether or not to make changes. For example, for couples with different levels of income, a different split could be more appropriate. Additionally, some use a fixed dollar amount rather than a % of income.
5. I'm curious about the difference between financial planners and financial advisors. Which one should I have, and at what stage of life should I talk to one?
A financial advisor is someone who helps clients manage their money. It can be thought of as an umbrella term that includes different types of financial advisors, such as financial planners.
The decision to use a financial advisor, and finding the advisor that is right for you, is highly personal and depends on your unique needs, preferences, and behaviors.
When considering whether or not to partner with a financial advisor, a good place to start is by evaluating the amount of time you are willing to spend managing your financial plan, and your level of discipline in sticking to this plan on your own. Consistency and discipline are key to achieving long-term investment success, so if you find yourself deviating from your plan often, or if you find yourself becoming overwhelmed with managing your portfolio, it could be a good idea to consult a financial advisor.
When determining the right financial advisor for you, it’s important to find someone you can trust. Although trust is built overtime, there are a few things you can look for to help you determine if you’ll be able to establish trust with an advisor. A good place to start is by determining whether the advisor is a fiduciary, which means they are required to put your best interests first. Understanding the compensation structure of the advisor is also key in determining that there are no conflicts of interest. From there, you can then ask questions to determine whether the advisor’s investment philosophy aligns with your unique needs and long-term goals. Overall, financial advisors can provide significant value and finding one you can trust to always put your best interests first is essential.
6. What resources are available for those of us who can’t afford an advisor or planner?
Thanks to the internet, there are now so many different resources that can be used to understand finances and investing. A good place to start is on the Vanguard website, which provides investing information for individuals at all stages of the investing journey.