When Might Be the Best Time to Start Saving for Retirement?
“What are your thoughts on retirement?” I asked that question to a handful of my millennial peers and fellow millennial crusaders.
But it’s not the thought of retiring to the sandy beaches of Florida with a piña colada in hand that makes retirement so appealing to me — although, that does sound nice.
No, I love how the act of saving for retirement gives me and my peers a seamless entry point to become investors without even thinking about it. Suddenly, we’re allowed access to real returns, compound interest, tax advantages, and need I mention free money. (More on that in a bit.)
All these benefits available to you, just for putting a little extra away for your future self.
From some of the responses I got, though, I wonder if I am alone in this love affair with retirement planning.
“There are so many other financial things that I am trying to get in order that I don’t place a ton of focus on retirement because I feel like that can wait.”
“It’s sort of hard to plan for retirement when you don’t really have a career to retire from.”
“I’m just trying to get past mile five. I will think about mile 25 when I’m closer to it.”
Saving for Retirement Doesn’t Have to Be Difficult
I can’t say I blame them. With what feels like an insurmountable college debt burden hanging over our heads as we enter the workforce, matched with the fact that entry-level salaries haven’t exactly kept up with inflation, millennials have it tough when it comes to keeping their financial ducks in a row.
With that said, I can’t quite relate to the idea that retirement is a “bridge to be crossed when I get to it.” Probably because I spend my days scouring the Internet for beautifully crafted graphs and data points of Tom and Mike. Who are Tom and Mike, you ask?
Tom, who started investing $5,000 per year from age 25 and stopped at age 35, always beats Mike who starts his $5,000-per-year investment at age 35.
By the time Mike has put his first installment in, Tom will have saved an impressive $79,350. At the end of their individual savings journeys, Tom will have a cool $455,744 at age 65, while Mike will lag behind with $449,449. And if Tom continued investing after age 35, he would have a little over twice as much as Mike! (Calculation based on a conservative annual average yield of six percent.)
The truth is, the longer we wait to contribute to retirement, the longer we’ll have to work into retirement just to afford our most basic needs. We’re living longer, too. And with social security looking less favorable by the minute, I’d say that ramping up your savings now is beginning to look like the best option.
Okay, so I’ve swayed you. Now, what are your options?
These are the most common employer-sponsored retirement plans. The 401(k) is the staple retirement plan of most for-profit corporations, while the 403(b) is a similar plan used in non-profits. These plans allow you to deduct a portion of your wages to be set aside, pre-tax, in a retirement account. As an added benefit, your employer may offer to contribute to your 401(k) (or, more rarely, to your 403(b)) in the form of a matching contribution. If offered a matching contribution, always make sure to invest at least the maximum percentage of your income that your employer will match. This is free money!
Individual retirement accounts, both traditional and Roth, are options outside of employer-sponsored retirement plans. The maximum you can contribute to these accounts (in total) is $5,500 for 2018. if you’re under 50 and $6,500 if you are 50 or over.
The traditional IRA may allow you to contribute on a pre-tax basis, but you have to pay tax when you take the money out in retirement. With a Roth IRA, you invest after-tax money, but as long as you leave the money in the account until six months or more after your 59th birthday, you never have to pay another dime to the taxman on the money you invest there.
If you’re a freelancer, independent contractor, or otherwise self-employed, the SEP IRA is a great alternative to the employer-sponsored plans. A SEP IRA stands for Simplified Employee Pension IRA.
The plan works similar to the IRA, but your contribution limits are raised. For 2018, you can contribute up to either 25 percent of your income or $55,000 — whichever is less — to a SEP IRA.
The one drawback for many retirement plans like the Roth IRA is that taking money out before a certain age can cause significant tax consequences, including making the money taxable and costing penalties on top of the tax.
That is the trade-off for the tax-favored treatment — it really is money for retirement, with few exceptions. But that doesn’t mean it’s not worth it.
My best tip for wisely saving and investing in your retirement is to automate the process. This should be very easy to do through your employer. Set your deductions to automatically come out of every paycheck. If you don’t see that money come into your bank account, it’s like it was never available for you to spend in the first place.
For the other retirement plan options, the provider with whom you choose to set up your IRA, Roth IRA, or SEP IRA should have automatic deduction options that will take it from your bank account. Make it happen close to the day you get paid and you’ll hardly notice a thing.
Retirement may not be the sexiest term in the financial dictionary — especially when it’s 40 years away — but “investing,” “free money,” and “tax advantages” sound pretty good to me. It’s time to start paying your future self, realize the power of investing early, and recognize the magic of compound interest.
Though you may immediately think of retiring to the sandy beaches of Florida with a piña colada in hand, that’s not why I like thinking about retirement. Those piña coladas aren’t free, but your employer contributions, tax savings, and invested returns sure help pave the way.