If you're thinking about retirement and the money you'd like to save up ahead of time, there are a few tips on when--and how--to get started.
The Sooner, the Better
The simple, straightforward answer to this common question is that the ideal time start saving is as soon as possible. The main reason for this is that money saved earlier in life has more earning power because it has more time to grow before it’s time to retire. CNN Money offers this explanation:
Suppose you start putting $3,000 per year into a tax-deferred retirement account at age 25 and continue this for ten years. Even if you never deposit another penny into your retirement account after age 35, assuming a seven percent rate of annual return, your $30,000 investment will have grown to $338,000 by the time you reach age 65.
On the other hand, if you were to wait until age 35 to start saving, that same $3,000 per year will grow only to about $303,000 before you turn 65, even if you make these contributions for the full 30 years (for a total investment of $90,000). That means by starting ten years earlier, you can end up with a substantially larger nest egg even though you started with one third of the investment.
Learn more about financial planning in your 30s!
Options for Retirement Savings
Retirement accounts, including 401(k) plans and individual retirement accounts (IRAs), are sensible vehicles to begin saving for retirement. Which account or combination of accounts will be most beneficial for you depends on what you qualify for as well as your current and projected income levels.
A 401(k) plan lets you contribute a portion of your pre-tax earnings to your retirement fund. While it can be tempting to look at your salary as the bottom line in an employment offer, benefits are an important part of your compensation package. If you’re fresh out of college or trade school and looking to land your first professional job, pay attention to whether each potential employer offers a 401(k) plan and if so, whether and how much the employer will contribute to it. If you work for an employer that provides a matching contribution for its 401(k) plan, this can provide a helpful jump start.
Employers in some industries are more likely to offer 401(k)s and matching contributions than others, and larger companies tend to offer larger contribution matches than smaller employers. Three percent of salary is a common maximum employer contribution; however, some employers don’t provide any matching contribution, and others will contribute up to ten percent of employees’ pay to their 401(k)s. Looking again at the example above, you can see that starting a new job at age 25 that pays $30,000 with a 10% employer matching contribution to the 401(k) would result in double the contribution we see in the first scenario and a much more comfortable retirement fund.
401(k) plans let you put more money away than IRAs, with a limit of $19,000 for 2019 (plus an additional $6,000 for those 50 or older). This limit only applies to what employees contribute from their earnings and does not include employer contributions. The combination of tax deferment, the potential for employer contributions, and high contribution limits make the 401(k) a very effective way to save for retirement—especially if you get started early.
There are two broad types of individual retirement accounts—traditional IRAs and Roth IRAs. These are sound, tax-advantaged options for those who don’t qualify for a 401(k) through their employers. In some cases, they can also be beneficial investments for those who have maxed out their employer matching contributions to their 401(k)s.
A traditional IRA is available to anyone under the age of 70 ½ who receives taxable compensation. Contributions may be tax deductible, but most workers (those under age 50) can contribute only up to a total of $6,000 to any IRA in 2019. Those age 50 and older can contribute an additional $1,000.
A Roth IRA is available only to those who fall below specified income limits. In 2019, taxpayers can contribute up to the $6,000 limit to a Roth IRA if their adjusted gross income is less than $122,000 as a single filer or $193,000 on a joint return. Single filers who earn at least $122,000 but less than $137,000 and joint filers who earn at least $193,000 but less than $203,000 are eligible to contribute a reduced amount.
An important difference between a Roth and a traditional IRA is how the funds are taxed. While contributions to a traditional IRA are contributed before tax and taxed upon withdrawal, Roth IRA contributions are deposited after tax and are potentially tax free upon withdrawal. This difference makes Roth IRAs preferable for workers who would owe little or no income tax today, particularly if they expect to be taxed at a higher rate when they begin to take withdrawals from their retirement account. For this reason, a Roth IRA can be a smart way for a teenager to start saving with their very first job!
If you’re ready to start planning for your retirement, the professionals at Boelman Shaw Tax and Financial Planning can help. We can educate you about your savings and investment options and assist you in making financial choices to meet your goals.