Couple discussing what a retirement fund is and how to start one.

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Retirement Funds Guide: Definition, Types of Funds & How to Get Started

Starting a retirement fund is a great idea for any age! Learn how retirement funds work, and get helpful tips for starting yours today.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

One of the boldest steps you can take toward securing your financial future is to start a retirement fund. Oftentimes, getting started is the hardest part. That’s because going from not saving to saving requires change and commitment. It’s also because much of today’s financial wellness advice is geared toward individuals who have already started saving, and have been saving for quite some time. Much of this can be overwhelming if you don’t know where to begin. 

This guide will introduce you to everything you need to know about retirement funds: what they are, how they work, when and how to start one. You’ll leave this space having the basics you need to start saving so that you can start building momentum and your confidence. 

What is a Retirement Fund? 

A retirement fund is a long-term investment account that allows an individual to save for retirement. By setting aside portions of your current income towards the future, you can take advantage of certain tax benefits. Further, retirement savings and investment accounts benefit from compound interest, meaning that the amount you are able to save today will grow exponentially by the time you retire.

The retirement funds definition shouldn’t end there. An important aspect of building a retirement fund is retirement planning. This is the process of creating financial goals for retirement, creating a strategy on reaching these goals, and taking aligned actions. Retirement planning can help ensure that you are on track to saving up enough money for retirement so that you can cover your expenses and maintain a certain lifestyle long after your final paycheck. Learn how to plan for retirement in detail in our retirement planning guide. 

How Does a Retirement Fund Work?

In general, a retirement fund works by tucking away portions of your income into a separate retirement account over a long period of time. Your contributions can be withdrawn from your paycheck or personal financial account manually or automatically at regular intervals, such as once monthly. 

Employees of companies are often incentivized to contribute pre-tax income into a sponsored retirement account, such as a 401(k). Not only do they get to save for retirement, they also get to reduce their taxable income. 

However, there are several different types of retirement funds that work in unique ways.

3 Different Types of Retirement Funds

There are several different types of retirement funds that individuals can contribute to. Choosing the right one depends on whether or not you’re employed with a company that offers retirement benefits, as well as how much you’re contributing. 

Your decision can also be influenced by the different sets of advantages and disadvantages offered by various types of funds. Note that there are a wide variety of retirement funds to choose from, as well as other unique ways to save for retirement. For now, here is a basic introduction to the 3 most common types of retirement funds used by many Americans:

  1. 401(k)

  2. Traditional IRA

  3. Roth IRA

1. 401K

If you are employed with a company, a 401(k) is often one of the most convenient retirement fund options to take advantage of. As an employee, you won’t have to pay any fees to open or maintain your account. To contribute, you’ll generally agree to divert a percentage of your paycheck into your retirement account. 

One of the key benefits of a 401(k) is the opportunity to tuck money away for retirement in a tax-deferred environment. You usually contribute pre-tax income to this account, meaning that your taxable income is lower. Further, your retirement savings grows tax-free until you start making withdrawals during retirement.

Another great reason to take advantage of a 401(k) is employer matching. Many employers that offer a 401(k) also offer a matching program. This means they will match whatever amount you contribute each month, doubling your retirement savings.

One disadvantage associated with a 401(k) is its limited number of investment options, such as mutual funds. If you wish to save for retirement using other types of investment vehicles, you’ll want to supplement your savings with additional accounts.

2. Traditional IRA

An individual retirement account (IRA) allows individuals to open and manage retirement savings plans independently, outside of any employment benefits they may have. Virtually anyone with a taxable income can contribute to a traditional IRA.

IRAs offer many of the benefits of a 401(k), such as reducing your taxable income, and allowing your money to grow in a tax-deferred environment. There are also similar age restrictions for when you can start making withdrawals without penalties.

Many individuals are drawn to IRAs because they allow you to take advantage of a wider variety of investment options (relative to a 401(k).) You can certainly take advantage of your employer’s 401(k) plan while also opting into your own IRA plan. However, be wary of the contribution limits. These are often much lower compared to 401(k) contribution limits. 

3. Roth IRA

A Roth IRA is similar to a traditional IRA, except for its tax structure. With a traditional IRA, you don’t have to pay taxes on the contributions you make. However, you have to pay income taxes when you take the money out.

In contrast, the Roth IRA has an opposite tax structure. Instead, you pay taxes on the money you contribute today. In exchange, you’re not taxed when you make withdrawals during retirement. Some individuals wish to take advantage of a Roth IRA because they’d rather have larger withdrawal amounts in retirement without having to worry about future tax rates. If you feel like your retirement income will be larger than the income you have today, then it’s also a good option. 

Disadvantages of a Roth IRA to consider: no tax break for contributions you make today, income restrictions, and lower contribution limits.

Tips for Starting a Retirement Fund

Once you’ve committed to starting your retirement fund, it’s time to take action! Earlier, we went over several of the most common types of retirement accounts to choose from. Most financial advisors would agree that it’s smart to take advantage of an employer-sponsored 401(k) plan if you have access to one, especially if they offer employer contributions or matching. Otherwise, you’re essentially leaving free money on the table. 

After you’ve maxed out your 401(k) contributions, you also have the option of supplementing your retirement fund with additional types of savings and investment accounts. That way, you can add a wider variety of options to your portfolio if you so wish.

Once you’ve opened your account, your vessel for building your retirement fund, you’ll now focus on building up your fund.

Here are  some helpful tips as you start contributing to your retirement fund: 

  • Pay yourself first: Many people who don’t save for retirement already feel like they don’t have enough to cover their expenses. However, with this mindset, you won’t ever save. If you’re finding a way to pay your rent or your car loan, then you can likely afford to tuck away some money toward retirement, even if it’s just $50 per month. Pay yourself first and automate your savings so that you don’t miss the money and don’t feel tempted to spend it.

  • Start small: The key to successfully building your retirement fund is to contribute to it consistently over a long period of time. Some individuals feel tempted to play “catch up” and commit to a monthly contribution that is more than they can comfortably afford. When doing so, they may be tempted to withdraw their investment to cover their expenses. Instead, start small and build up over time.

  • Don’t get too risky: If you choose to invest in the stock market, be realistic about how much risk you can afford. If you are young, then you have enough time to recover from market fluctuations. However, this is your precious nest egg so you don’t want to get too wild with your investment decisions. Avoid the riskiest areas of the market. Basic index funds are a great place to start.

  • Diversify: Similarly, you don’t want to put all of your eggs into one basket. If you want to maximize your expected return, you may want to put most of your funds into a slow and steady investment, such as a mutual fund, but then mix in some riskier investments that offer higher potential returns such as individual stocks or index funds.

  • Project retirement savings: Be sure to calculate your projected retirement savings at regular intervals to make sure that you’re on track to hit your savings targets and final goal. Not sure how much you should be saving? Check out our guide, Stages of Retirement Planning by Age, which goes over how to calculate your overarching savings goal, as well as what benchmarks you should be hitting by age.

Make Sure Retirement Funds Are Included In Your Estate Plan 

What is a retirement fund? If you visited this space looking for the answer to this question, we hope that you now feel confident with what you’ve learned. In summary, a retirement fund is a special savings account that sets aside funds that you plan to use in retirement. These accounts are usually investment accounts that leverage compound interest to help your money grow exponentially over time. The key is to start saving early in life; small, consistent contributions are better than large, sporadic ones. 

This guide also went over common types of retirement accounts to choose from, as well as tips on how to get started. 

While you’re thinking about retirement, don’t forget to also be thinking about your Estate Plan! Estate planning is an important aspect of protecting your personal assets should anything happen to you. Further, your Estate Plan can include your wishes regarding your future health care and end-of-life planning. Take our free quiz to see where you should get started, or compare our different estate planning and settlement  options today!

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