College graduation: check. Landed your first real job: check. Making real money: check! Next step: start saving for retirement. You might be thinking, “Are you serious right now?” Yes, the best thing you can do for your future self is to start saving for retirement while in your twenties. Let’s take a look at the why and the how of achieving your best future life.
Why Start Saving Now?
What’s the rush with saving for retirement? You might feel like you’ve got lots of time to save for it. Plus, there are more pressing financial decisions to make right away: purchasing a car, renting an apartment, and paying on that student loan. There’s also budgeting for food, insurance, and maybe taking that post-graduation trip. But now is the best time to start saving for retirement! Here’s why:
Time is on your side. Because you’ve got around four decades before you retire, you have the advantage of compound interest doing what it does best: grow. Your money will make you more money. A retirement calculator can help you figure out how much you need to save.
Money doubles over decades. The Rule of 72 is a formula that allows you to calculate how many years it takes for your money to double. Divide the number 72 by the percent return to find the number of years to double your money. For example, $5,000 earning 10 percent will double in 7.2 years. You could have $10,000 saved before you turn thirty. Waiting until your thirties to start means losing out on a decade of doubling.
You can start with less. Because you are starting early, you can invest less money because it has more time to grow. If you start your retirement savings in your forties, you’d have to contribute a larger part of your income to save what you will need in retirement. Want to have $1 million by the time you are in your sixties? At 22, you would need to save $3,600 per year (assuming 8 percent return), but at 29, you would need to save $6,400 per year to reach the same goal.
Good habits are developed. Saving for retirement early on in your career creates a consistent financial habit. Once you see your money growing, you get motivated to keep saving. It can be harder to embark on a pattern of saving once you are married, have children, and experience larger expenses.
How to Start Saving for Retirement
Now that you’re finished with college, your education days are over, right? Maybe academically, yes. But financially, it’s wise to get educated about how to budget, save, and invest. Let’s look at what, where, and how much.
What kind of retirement account should I open?
401(k). The easiest place to start is to look at what your employer offers. Many companies have a 401(k) plan, to which you can contribute out of your paycheck. Benefits of a 401(k) include:
● Usually, employers will match your contribution. That’s free money that you don’t want to pass up! The current maximum employee contribution is $20,500 per year.
● You can deduct your 401(k) contribution from your annual taxes. Contributions are pre-tax, so you don’t have to pay tax on them until you withdraw the money in retirement.
● A Roth 401(k) is another option. Contributions are after tax, so your money grows tax-free, and you don’t have to pay tax upon withdrawal.
● These plans are protected from creditors and federal liens. Because your employer owns the 401(k), creditors cannot get to them and your money is protected.
IRA. Individual Retirement Accounts (IRAs) are plans you start yourself. To qualify, your income must be less than $129,000 (for singles) and the current max contribution is $6,000. There are some unique benefits of an IRA:
● Roth IRA: You are paying tax on your contribution up front. When you draw on your account in retirement, the money will be tax-free.
● Traditional IRA: These are pre-tax accounts. You can take the tax deduction the year you contribute. Tax is paid upon distribution in retirement.
● They don’t have a required minimum distribution (RMD) once you reach a certain age. You can continue to contribute to them as long as you have earned income, regardless of your age.
Where do I set up my accounts?
If you have a 401(k), it will be set up by your employer. But what if yours doesn’t offer that plan, and you have to go it alone? Deciding where to invest your retirement savings is important.
● Your choices include: banks, brokerage companies, credit unions, savings and loan associations.
● Things to consider: costs and fees, user-friendly website and apps, availability of customer support (either at a branch, online, or phone).
How much should I be saving?
The short answer: as much as you can. Setting a goal to have a specified amount of money in retirement savings by a certain age is good. Saving 15% of your paycheck is a good place to start. But even if you don’t have a particular number in mind, you should be putting as much as you can into a retirement account while you are in your twenties. Some people call this front-loading. Maxing out contributions to your 401(k) and Roth IRA while young, single, and financially flexible allows you to take advantage of compound interest and provide you with more options as you get older.
You may not be at a point in your life that you need a financial advisor to assist you in managing your money. But you may need help to put together a plan to get you started on the right financial path. Contact us to get a conversation started. We are here to help!
Written by Matthew Delaney