Graduating college can be an exciting and stressful time. It’s the close of one chapter and the beginning of another. As a new grad, you’re coming into your own and putting those useful years of study to work in your respective field. Not only is graduation a wonderful time to start your career, it’s also a great time to prepare for your financial future. The best way to plan for you financial future? Start saving for retirement — now.
Why the Time Is Now
College graduates who are typically in their early 20s have a unique advantage: the gift of time. Although retirement could be 40 years away, it’s important to start saving now to reap the benefits later. Start early — the time is now!
The more time you have to save the more you’ll benefit from the magical power of compounding interest.
For example: At age 20, if you make a one-time $5,000 retirement savings deposit in a Roth IRA account earning 8%, and you don’t touch those funds, at age 65, you’ll have $160,000. If you wait until age 39 to make that one-time $5,000 contribution, at age 65 you’ll have only $40,000.
Do you see the difference? Time is on your side when it comes to retirement planning, so use it wisely. If you think retirement is far off, think of it instead as long-term savings.
1. Create a Long-Term Plan
College grads who move immediately into the workforce should take part in their employee-sponsored retirement plans. For most people that is a 401(k). If you work at a nonprofit or school, you will be offered a 403(b).
What’s the difference? According to the tax code that defines these plans, one is for profit institutions, while the other is for tax-exempt institutions. Each does the same thing, saves your money and compounds over time.
Compounding interest is a gift to your future self. Pay now, and enjoy later. If you don’t have a job lined up, that doesn’t mean you can’t start saving for retirement. You can opt for a Traditional IRA or a Roth IRA. IRAs, or Individual Retirement Accounts, give you a lot of options.
Traditional IRAs are accrued on a tax-deferred basis. Once you are 59½, you can withdraw money but you will be taxed on that money, as income. With a Roth IRA you can fund your retirement through non-tax-deductible contributions. Earnings accrue on a tax-free basis, and you can withdraw money at 59½ without any extra tax burden.
There are contribution limits to both plans. To learn more, explore the differences between these plans.
Regardless of what plan you have, it’s important to rollover any investment money if you change jobs. Don’t let your money go to waste — let it work for you! And avoid the temptation to cash out your funds, which not only results in loss of your savings but can also result in additional taxes and penalties.
2. Diversify Your Investments
Once you’re comfortable starting to invest, explore the variety of investment options available. Look into investing in the stock market, mutual funds, and more. There are even innovation-based investing services that cater to a younger, more tech-savvy market.
Diversify your income streams as well as your investment portfolio and you will set yourself up for a secure future. Before investing, evaluate your risk tolerance — which basically means how comfortable are you with investments that can fluctuate?
Will risky investments which generally provide more return, keep you up at night or are you comfortable with risk? There are many risk-tolerance tools online that can help you assess your tolerance to risk.
3. Automate Your Savings
Set up an automatic payment plan — it’s easy to adhere to and you’ll hardly know the money is gone.
Set up the amount as a percentage rather than a dollar amount so the figure will automatically adjust as your pay changes.
Does your company provide a match? If they do and you aren’t contributing, you are leaving money on the table. You wouldn’t leave vacation time on the table, would you, so why leave company match dollars on the table?
Another advantage of setting this up through work is that your savings amount will be pre-tax. This means if you make $50,000 and you contribute $4,000 per year, you are taxed on only $46,000 instead of $50,000.
If you have to pick your investments but aren’t sure how or are intimidated with all the terminology (large cap, mid cap, TIPS, etc.), use a simplified investment strategy. Many companies will offer lifecycle (sometimes called target date) funds geared to the estimated year you’ll retire. These funds have a mix of underlying investments that will automatically adjust as you get older.
Many companies also have representatives who can guide you. Set up an appointment and get started.
4. Enjoy Your Money Later
Once you start saving for retirement, it’s important you don’t touch the money — it’s for your long-term savings and it will have tax consequences if you take it out early.
Starting your long-term savings now as opposed to later will ensure you are prepared for retirement and able to enjoy it, instead of scrambling and working until you’re 80.
What other retirement advice would you give to a new college graduate?