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    What's the Best Way to Save for Retirement When Your Employer Doesn't Offer a Plan?

    August 15, 2012

    Dear Carrie,

    I'm 27 and my husband is 32. We're starting to think about saving for retirement. He has a 401(k) at work, but I'm a hairstylist at a small salon that doesn't offer any retirement benefits to its employees. What's the best way for me to save?

    A Reader

    Dear Reader,

    First, kudos to you both for some smart thinking. Starting to save for retirement early is one of the most important things you can do. At your age, if you save just 10-12 percent of your annual income from now on, you should be in pretty good financial shape come retirement. At your husband's age, he might consider bumping that up to 12-15 percent.  

    My first thought when reading your question is that it’s too bad that you’re not self-employed because that would allow you to save more in a retirement account. And.your husband's 401(k) makes it a bit easier for him because the money is taken automatically from his paycheck each month (plus, his employer may “match” some of his savings as an incentive). But given that you don’t have a savings plan from your employer, you’ll simply have to set up your own retirement account and contribute to it every month. And then if you’re able to save more in a regular investment account, that’s even better. Here's what I suggest.

    Open an IRA

    An IRA is an Individual Retirement Account that you open in your own name. It's considered a tax-advantaged account because it allows retirement savings to grow tax-deferred, which means you don't pay income taxes on the earnings as long as the money is in the account. Currently, you can contribute up to $5,000 a year to an IRA. That would be a good start to your savings.

    You have a couple of IRA choices, so before you open one you'll need to consider which is best for you.

    • Traditional IRA—With this type of account you generally get an upfront tax deduction for your contribution. Earnings grow tax-free but you do pay ordinary income taxes when you make a withdrawal. If you withdraw your money before age 59½, there's also a 10 percent penalty—a good inducement to keep your money growing.
    • Roth IRA—With a Roth, there's no up-front tax deduction for a contribution, but you can withdraw funds income tax free at age 59½ if you’ve held the Roth for five years. You have to pay tax if you withdraw earnings (as opposed to your contributions) in the first five years, and there will also be a 10 percent penalty if you withdraw earnings before 59½. However, there's never a penalty for withdrawing the money you contributed.

    There are income limitations to qualify for contributing to a Roth. For 2012, if you're married filing jointly, you can make a full contribution as long as your modified adjusted gross income is less than $173,000 (less than $110,000 for single filers). A Roth might be the best choice for you if you meet the income qualifications and don't need an upfront tax deduction. Those tax-fee withdrawals could be a real plus if you're in a higher tax bracket down the road.

    You can open an IRA at a bank or investment company. Look for one that has a low minimum for opening a new account. And don't be afraid to ask questions. A representative should be happy to sit down with you to make sure you understand the details.

    Set up an automatic contribution

    Once you've opened your IRA, make contributing to it easy by setting up a monthly automatic deposit from your checking account to your IRA. A $5,000 yearly contribution comes out to just a little over $400 a month. If that's more than you can manage, contribute as much as you can and make up the difference with any bonuses, raises or gifts. You actually have until the tax filing date of the following year to make your full IRA contribution.

    Invest your IRA savings

    The next step is to get your money working for you. Since you're young and have a long time frame, I suggest investing in one or more broad-based stock mutual funds or exchange traded funds that represent different companies, industries and countries. Or you could invest in what's called a target fund that corresponds to your retirement date. When you open your IRA, talk to the representative about investment choices. Many financial service companies offer free advice.

    Save even more

    An IRA is just the beginning. As you and your husband earn more money, consider putting even more away in a taxable account for both your short- and long-term goals. And don't forget to set aside at least three months expenses in an emergency fund. That way, you'll not only be saving for your individual retirements, you'll be planning and saving for a more secure financial future together. Best of luck to you both.

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