You probably aren’t thinking about retiring. But that’s actually a bigger problem than you might think. If you wait until you’re ready to retire to start thinking about whether you can afford to live without a regular paycheck, you’ll have missed the boat. The time to start retirement planning is right now. 

That explains why many employers, including the DoD, want you to participate in their retirement savings plans. It’s also why the federal tax code provides tax incentives for contributing to one of these plans, opening an individual retirement account (IRA), or—even better—doing both. 

HOW EMPLOYER PLANS WORK 

There are two basic types of employer-sponsored retirement plans. In most cases, an employer offers one or the other, but some employers, including the DoD with its Blended Retirement System (BRS), offer both. 

In a defined benefit (DB) plan, often called a pension plan, the employer promises regular income after you retire. The plan document specifies how you qualify and includes a formula for determining the amount you’ll receive. Typically, the factors are how long you were employed and what you were earning at the time you retired or left the job. The employer contributes to a general pension fund and is responsible for managing its assets to meet plan obligations. 

In a defined contribution (DC) plan, you, your employer, and sometimes both contribute to an individual account that’s set up in your name. You defer a percentage of your salary, called your contribution, to your account each pay period and choose the way the money is invested from among the alternatives offered in the plan. The employer may match a percentage of your contribution, up to a cap. 

Unlike a pension, no specific amount of income is guaranteed after you retire. The amount you receive will depend on how much was contributed, the way the contributions were invested, the return the investments provided, and how long the account was open. 

PLAN INVESTMENTS 

In most defined contribution plans, the investment choices include a number of mutual funds and a fund of funds known as a lifecycle fund or target date fund (TDF). Plans that offer a lifecycle fund actually offer several similar funds, each linked to a specific date, such as 2040, 2050, or 2060. You choose, or, in the case of automatic enrollment, are assigned to the fund whose date is closest to the approximate date you’ll reach retirement age. 

A lifecycle fund allocates assets using a formula that stresses growth in the early years of the fund and gradually shifts to an emphasis on income and safety as the target date approaches. If you invest in individual funds rather than the lifecycle fund, you choose your own allocation. That means if you’re comfortable taking more or less risk than the lifecycle fund linked to your prospective retirement age does, you can invest to seek higher return or greater safety. 

ADDING AN IRA 

Whether or not you’re participating in an employer plan, you can contribute to an IRA. You open an IRA with a credit union, bank, brokerage firm, or mutual fund company—called your IRA custodian—and choose the investments you want from among those offered by the provider. That lets you diversify more broadly than you may be able to do in your employer plan. 

ARE YOU IN? 

Employers who offer pension plans enroll you as soon as you’re eligible to participate. Increasingly, that’s true in defined contribution plans as well, including in the DoD’s BRS plan. You’re enrolled 

automatically, and the percentage of pay you contribute is set initially by the plan. So is the way your contributions are invested. 

But you’re not locked in to these defaults. You can choose to contribute a different percentage, but there’s an upper limit and often a lower one. Similarly, you may want to make your own choices from the investment menu. In most cases, the way you allocate your contributions governs the way the employer’s matching contributions are invested. 

While you can elect not to participate in the plan, you’re working against your own self-interest.

COMPOUNDING IS KEY 

When you’re investing for retirement, starting as soon as you can is important because of the power of compounding. It’s the same process that works in your savings account when the interest you earn is added to the amount already on deposit, increasing the base on which the next round of interest is figured. 

Compounding works a little differently in a defined contribution plan than it does in a savings account. All your earnings are automatically reinvested to buy additional shares in the mutual funds you’ve selected. As that happens, and as you continue to make contributions, the number of shares you own increases. The more shares you accumulate, the more any increase in the fund’s net asset value (NAV), or share price, boosts the total value of your account. 

Of course the NAV could decrease rather than increase in any given period, based on whether the fund’s holdings lose or gain value. But your earnings still continue to buy shares. So when the NAV goes back up, the value of your investment may be even higher. 

When you contribute the same amount to an investment account every month, you’re using a strategy called dollar cost averaging. When the NAV goes down, you buy more shares, and when it goes up, you buy fewer. But you never pay more than the average price per share. 

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