How to Save for Retirement at Your First Job
Saving enough to retire comfortably is significantly easier if you begin to put away money for retirement at your first job. Tucking even a small amount into a 401(k) or IRA gives that money decades to accumulate without the drag of taxes, and compound interest will do much of the work of growing your wealth. Here's how to begin preparing for retirement at your first job.
Get a 401(k) match. Your first retirement savings priority should be getting a 401(k) match, which is likely to be the best return you will ever get on an investment. If your employer provides 50 cents for each dollar you save, that's a 50 percent return on your investment. And a dollar-for-dollar match instantly doubles your money. "Take advantage of any retirement matching funds that your employer provides in a 401(k) or similar retirement savings account," says Alan Moore, a certified financial planner and founder of Serenity Financial Consulting in Bozeman, Montana. "If they're willing to match up to 4 percent or 3 percent, make sure you are putting that amount aside."
Set up automatic contributions. A 401(k) plan makes it effortless to save because the money is withheld from your paycheck before you ever get a chance to spend it. Contributing just $50 per twice monthly paycheck will leave you with over $1,200 within a year. If you kept up that savings rate for 30 years and earned 6 percent annual returns, you would have nearly $100,000. And if you also receive an employer match of 50 cents for each dollar you save, it would grow to nearly $150,000 in 30 years. "Trying to save at least 10 percent of your income for retirement is a good rule of thumb," says Tyler Landes, a certified financial planner for Tandem Financial Guidance in Kansas City, Missouri. If you can't save that much, "save at least 3 to 5 percent of your income just to get started," Landes says.
Get a tax break. The money deposited in your traditional 401(k) plan is tax-deferred, meaning you won't have to pay income tax on your contributions or the investment earnings until you withdraw the money from your account. If you are in the 25 percent tax bracket, a $100 401(k) contribution reduces your tax bill by $25. And if you earn less than $30,500 in 2015 ($61,000 for couples), you can additionally claim the saver's credit on your retirement account contributions. This tax credit is worth between 10 and 50 percent of the amount contributed to a 401(k) or IRA, including Roths, up to $2,000 for individuals and $4,000 for couples.
Consider an IRA. If your employer doesn't offer a 401(k) plan, or that 401(k) plan offers no employer contributions and has high fees, consider saving for retirement in an individual retirement account. IRAs also allow anyone with earned income to defer paying income tax on money they deposit in the account.
Minimize taxes with a Roth IRA. Roth IRA contributions are made with after-tax dollars and withdrawals in retirement are typically tax-free. Roth accounts are often especially beneficial for young people with small salaries because they help you to lower your lifetime tax bill. For example, if you are in the 15 percent tax bracket in the year you make a Roth IRA contribution, you lock in that relatively low tax rate. Even if you jump into the 25 or 35 percent tax bracket later in your career or in retirement, you won't have to pay that higher rate on your investment earnings or Roth account distributions if you wait until retirement to take them. Some employers also provide a Roth 401(k) option that offers a similar tax deal. "If you don't have a company match at work, you might want to head straight for the Roth IRA," says Sophia Bera, a certified financial planner and founder of Gen Y Planning in Minneapolis. "Look into starting a Roth IRA at a discount brokerage firm, and set up automatic monthly contributions."
Choose low-cost funds. The expense ratio and other fees you pay to invest reduce the returns you could be earning. Make sure you understand the costs of each investment option you select. "I generally hope to find something less than half a percent, and ideally you can get 0.1 percent or 0.15 percent," Moore says. "The cheapest investments tend to be index funds and other low cost funds that are not actively managed."
Create an emergency fund. Retirement accounts typically have 10 percent early withdrawal penalties if you take the money out before age 59 ½. To avoid tapping your nest egg to cope with emergencies, it's essential to have some savings outside of your retirement accounts. An emergency fund can help you cope with sudden costs, while allowing your nest egg to continue to grow. "Even $500 to $1,000 would allow you to not use credit when an emergency comes," Landes says. "Longer term, building that up to 3 months of income is a better move."
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