In this chapter:
Introduction
Retirement savings plans
The 401(k) plan
IRAs
Roth IRAs
The IRA decision
How your savings grow
Some (minor) drawbacks
Dividing your savings
Inflation & taxation
A newfangled pension
Questions & answers
Security and your 401(k)
The scoop on IRAs
Your savings priorities
If you're self-employed
Financial cramming
 

How Your Retirement Savings Grow

The money in your retirement plan doesn’t just sit there; it’s channeled into investments so it can grow. When you sign up for a plan, you’re given a choice of investment options. You pick the ones you want and decide how to divide your money among your selections. 

Your options will depend on the kind of plan you enroll in. With a 
401(k), the employer typically narrows down the investment options for you. Many plans offer you a "menu" of about eight alternatives, which might include shares of your company’s own stock, a stock mutual fund, a bond mutual fund, a balanced mutual fund (which has a mix of stocks and bonds), and a money market fund. Every time you contribute, the money is automatically divided up according to your initial specifications. However, you may not get to choose how to invest your employer’s matching contribution.

IRAs are slightly more complicated because they involve more choices. First you must decide where to open one. Although IRAs are offered by banks and brokerage firms, your best bet is probably a large, low-cost mutual fund company.

Here’s why: When you open an IRA at a bank, your options may be limited to ultra-safe investments like certificates of deposit (CDs) and money market deposit accounts—neither of which typically offers a high enough rate of return to keep you comfortably ahead of inflation over the long term. While more and more banks also offer the option of putting mutual funds in your IRA, there’s a good chance you will pay a substantial commission on these funds. A full-service brokerage firm may also charge hefty fees. A no-load, low-expense mutual fund does not charge loads or commissions. 

Since retirement plans allow your money to grow tax-deferred (or tax-free in the case of the Roth IRA), you may want to consider the tax advantages (and disadvantages) of putting certain investments in them. For instance, it doesn’t make sense to put tax-free bond funds into a retirement plan; stick with taxable investments only.

A Lesson in How a Little Adds Up to a Lot

Although he has never earned more than $26,000 a year, Peter, 40, has more than $310,000 in retirement savings. How did he do it? Peter works at a company that allows him to sock away 17% of his salary each year into a 401(k). His starting salary in 1982 was just $10,000 a year, but he immediately began contributing the maximum he could to his company plan (even though his company offered no matching program), and has continued to do so ever since. For the three years he lived with his parents after college (he moved out at age 25), Peter also deposited an additional $2,000 into an IRA each year. Although it’s true that Peter profited by the fact that stock and bond funds did very well in the 1980s and 1990s, his real achievement has been his determination to contribute to his 401(k) and IRA every year. If he continues to save the maximum in his 401(k) plan, gets a 4% cost-of-living salary increase each year, and earns 8% a year on his investments, he will have more than $820,000 by the time he turns 50. Amazing.