By Carolyn Davis
Retirement seems like it's a lifetime away, so why worry about it now, right? You figure there's plenty of time down the road for thinking about retirement.
Well, sure—time is on your side. And you could wait, but would you want to if you knew there were hundreds of thousands of dollars on the line—the very dollars that could line your pockets if you start thinking of saving now rather than later?
Begin with at least 10% to 15% of your income to invest toward retirement. "People in their 20s aren't in the best position to save, as they haven't fulfilled many of the basic necessities that most people aspire to," says Douglas Rice, Ph.D. in finance and president of the Institute for Financial Planning Education of Castro Valley, Calif. "They typically don't have a furnished house, a solid career, or a settled family. All those things and more make it difficult for young people to focus on retirement—a vague concept that is far off into the distance. To put it differently: People in their 20s are in the best position to benefit from savings. This is because savings compounds over time, and they have more time."
So, it pays big to think about retirement now rather than later, and the effort now will make retirement that much sweeter.
put the power of time to work
Let's say your buddy begins saving for retirement at age 23 with just $100 a month until he's 60. The total amount he will have saved is $44,400. But with a 10% average rate of return on investing over those many years, the total amount he will have accumulated by age 60 is $465,983.
You decide to wait to start saving until you're 30 years old. Like your friend, you also plan to save $100 a month until age 60. The total amount you'd save is $36,000. With the same 10% average rate of return, you're looking at just $226,049. Not accounting for additional contributions or adjustment for inflation, your friend will come out $239,934 ahead of you at age 60. The cost of waiting until you're 30 to start saving means you'd receive less than half of what your friend would receive because he started in his 20s. In effect, you can never catch up.
"The biggest danger of pushing off retirement savings is that the amount you need to save to retire goes up every year, so the problem gets bigger and harder to solve," says Dr. Rice. "So by putting saving for retirement off, you end up making it worse and it can get so bad that you lose hope."
start small, but start now
Even if you don't have much money to start saving now, the good news is, it doesn't take much. According to Ornella Grosz, the 28-year-old author of the book "Moneylicious: A Financial Clue for Generation Y," you don't need to worry about producing a lot of money to invest—as long as you start now.
"When you're in your 20s, you can begin with a smaller amount, such as $100 per month, and increase your contributions as you make more money," she says. "By the time you reach your 30s or later, you're beginning too late to save for retirement, which means investing toward retirement with $100 per month is not enough."
Here's how to get started:
- Begin with at least 10% to 15% of your income to invest toward your retirement. "If that's too much for your budget, begin with $50 a month," Grosz says. That's just slightly more than $1.50 a day.
- Find out if your employer offers a 401(k) retirement plan. Grosz recommends taking advantage of this tax-deferred savings vehicle; it offers a consistent and automatic way to save for retirement. In addition to the elective deferrals you make, your employer also may offer matching contributions up to a certain percentage—that's free money to grow your retirement savings even faster.
- Resolve to devote part of every raise to your future. For example, if you get a 3% raise, put one percentage point of it toward your retirement goals. If you do this consistently over your working life, you'll accumulate a tidy sum by the time you are ready to start making withdrawals.
check out tax benefits of an IRA
There are two types of IRAs (individual retirement accounts): the Roth IRA and the traditional IRA. The main difference between the two is when you will pay taxes.
With a Roth IRA, you pay taxes on the cash going into the fund, but not when you take it out at retirement. With a traditional IRA, the money goes in tax-free, but you are taxed on the amount you take out when you retire. Each option has its pros and cons—for example, there are income limits for contributing to a Roth IRA, but not for a traditional IRA. There are contribution limits for both.
But for young adults just beginning their professional careers, a Roth IRA is often the more advantageous saving vehicle. "We don't know what taxes will be like by the time we begin to retire," Grosz says. "So, why not rely on a retirement vehicle to position you in case taxes are higher?" With a Roth IRA, you contribute with after-tax dollars that have been taxed at a lower rate. Then at retirement, you'll receive tax-free money on all your growth when taxes—more than likely—will be higher.
If you instead choose a traditional IRA, you'll pay taxes on the growth of your original tax-free contribution—at whatever your tax rate is at retirement.
Roth IRAs aren't for everyone, so be sure to check with a financial adviser or the professionals at your credit union. They'll help you weigh your options to make an informed decision based on your financial situation and goals.
save today for a sweeter tomorrow
It may feel impossible to think about retirement and saving at a time when you're just starting to make your own real money and have more appealing financial options, like buying a car or a house. But by paying yourself first, the money you save now will work harder for you in the long run, thanks to the power of time.