No, You Are Not Too Young for an IRA Why Young People Need to Save for Retirement 401K Retirement Plans Retirement Investments Ira Retirement Accounts Ira Tax Rules Cash Out Retirement No, You Are Not Too Young for an IRA This is how compounding works with friends recommending shampoo. Now, think of each friend as a dollar. Unlock Pension Income Now Retired? Have a Pension? NO BK 13? We Can Help. Get $3K to $18K Fast.
VA Loans for Veterans Have You Served? Vets Can Qualify. Loans up to $417,000 with $0 Down. Invest in FTTN A New Era Is Emerging In The Energy Market & FTTN is ahead of the curve See More About start saving for retirement basic investing compound interest money advice in your 20s 17.2% 2013 Annuity Return True Investor Returns with no Risk. Find out how with our Free Report. Annuities for Retirement Learn the Pros & Cons of Annuities! By Watching This Annuity Video 1st. It is a common shrug among people in their twenties, the retirement meh. “I’m too young to worry about retirement.” Or, “I’m too broke to worry about retirement, and I’m young so it doesn’t matter.”
In our late-blooming culture even some thirty-somethings exhibit the same indifference. Sorry kids, but you’re wrong. Name an age. That’s the right age to start putting money away for a rainier day. The fact is, you should start stashing even a small amount of money as early as possible into the market via a tax-deferred account like a 401(k), IRA, or Roth IRA (Roths are particularly attractive for young people, you’ll see why in a minute). Learn that early enough, and you will be the envy of anyone who understands compounding. Wait, What’s Compounding? Compounding or the compounding effect is the way something grows. I’m just old enough to remember those Faberge commercials from the 70s and 80s where “she tells two friends, and they tell two friends, and so on, and so on, and so on…” and pretty soon the screen is filled with people. Replace the shampoo zealot with a dollar and that’s compounding interest. Your interest earns interest, and that interest earns interest, and so on, and so on, and so on. In a tax-deferred retirement account, where you don’t have to worry about paying taxes on your earnings every year, those earnings multiply in a way that seems magical but isn’t.
Not every year is a good year of course, markets don’t usually double and there are years when investments lose money. But over time the markets have returned around 8% to 10% on average (of course, past performance is no guarantee of future results). To have that kind of annual interest multiplying… er, compounding, is what creates wealth. And the longer you are in the market, the faster it could multiply. I said it seems like magic, remember? In a popular example of compounding money, here’s a choice: You can earn $1,000 a day for 31 days, or you can earn one penny for your first day of work, and then double that amount the second day and so on. Which would you choose? Before you decide, remember the shampoo woman and her friends. You still want to take the $31,000 don’t you? How about $10,000 a day for 31 days? $310,000 is a no-brainer, right? Believe it or not, the wise choice is the pennies. A basic calculator can help you determine the total you would have at the end of 31 days, but I’ll give you a hint: It’s more than $10 million dollars ($10,737,418.24 to be exact). Ta da! Time Is On Your Side Granted, you aren’t likely to get either of the above offers, so here’s a little less dramatic (but — spoiler alert! — still pretty magical) way of looking at compounding. Take two twins: Brandon and Brenda.
Hardworking, conservative Brandon gets a job at 18 and puts $100 of every monthly pre-tax paycheck into an individual retirement account (IRA) or 401(k) plan. (The pretax part is important: because the money is taken out before you are taxed, your paycheck won’t likely take a $100 hit.) He invests well and earns 10% a year on average until he is 68. He always contributes the same small amount: $1,200 per year or $100 per month. At age 68 he has $1,396,690. Brenda doesn’t settle into the working world as Brandon. She flits around for awhile before landing a good job, and around age 28 she starts contributing $100 per month (same as her brother), and also earns 10% a year. At age 68, she’ll have $531,111. A nice sum, for sure, but less than half of what her brother earned with only 10 years’ advantage. If she waits until she’s 38 until she starts her $1,200 per month contribution, she’ll have $197,392 at retirement. If you are slightly less than young, these numbers should motivate rather than depress you. First of all, over time you will contribute far more than $1,200 per year. You may start with that small of an amount but ideally you want to aim to contribute 6% to 10% of your pre-tax salary into your 401(k). As you become more financially stable, try to max out your contributions. That will boost your numbers regardless of when you start. If your employer offers a 401(k) match, that alone can increase your numbers by up to 50%. Plus, those who are nearer to retirement get extra savings incentive from the federal government, known as catch-up contributions.
There are a lot of ways to save for retirement if you are starting late. Where Young People Should Save for Retirement If you have a 401(k), and especially if you have a 401(k) match, start there. But there’s another advantage that most young people have: low taxes. If you are just starting out and expect to climb tax brackets during your career, this is a great time to put some after-tax money into a Roth IRA. Money in a Roth grows tax-free and is typically not taxed when you take distributions. Pay taxes today for the right to avoid high, and potentially very high taxes in the future. If your employer has a Roth 401(k), invest there. The plans work exactly the same as regular Roth IRAs, but contributions are withdrawn from your after-tax paycheck. Let’s review: The best bet is to save up to your what your employer will match (typically 6%) in a 401(k), then allocate an additional percentage or dollar amount to your Roth 401(k). If your employer doesn’t offer a Roth 401(k), you can do the same thing with a regular Roth IRA through a brokerage (in many cases even the direct funneling from your checking account or paycheck). The only difference is that Roth IRA contributions are limited to $5,500 in 2013 (up from $5,000 in 2012). Contribution limits for a Roth 401(k) are much higher. You can put in as much as $17,500 in 2013 (up from $17,000 in 2012), same as a regular 401(k). If you don’t have a 401(k) through an employer but have some extra cash (graduation gift, inheritance, etc.) start with a Roth IRA through a brokerage like Fidelity, Vanguard, T. Rowe Price, or other respected brokerage or financial institution offering low-fee investments. If you are working as a freelancer or consultant, looking into a self-employed IRA, which offer generous tax breaks. Now Is the Right Time to Save, Regardless of Your Age There are a lot of other things you can do to save money and build wealth throughout your life. (Take a look at About’s Money in Your 20s site for good advice and resources.) But you will also make some mistakes, neglect certain things and learn tough financial lessons. We all do. These types of blunders are a lot easier to deal with when you are sitting on a fat financial nest egg. The bottom line is, no matter what your age, if you aren’t saving today, today is the day to start! And even if you are saving today, it’s a good time to think about saving a little bit more. Time is indeed on your side, but you have to take advantage of it.
The content on this site is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities. Where to Start Saving When You Are Young How Much Should I Save for Retirement? 6 Types of Retirement Plans You Should Know Your First 401(k) Suggested Reading How Much Can I Contribute to a Roth IRA in 2012? Understanding the Roth 401(k) Roth Iras Why Roth IRAs Matter More Suggested Reading Contributing to a 401(k) and a Roth IRA – You Can Do It! How to Begin Saving For Retirement Saving For Retirement With Help – The Saver’s Credit Related Articles Saving Your 401(k) Retirement Plan – What Steps Should You Take to Save You… How to Plan for Retirement at Every Age New Investor’s Guide to the 401(k) Plan It’s Never too Early or too Late to Start Investing for Retirement Retirement Savings Goals