While planning for retirement might be the farthest thing from the mind of most Millennials, this is precisely the time to be laying the groundwork for a solid financial future culminating in a comfortable retirement. Here are a few retirement planning steps Millennials should be taking now.
Start Saving Today
Whether you’re just starting your career or are a few years in, it is important you contribute to your employer’s 401(k) or similar defined contribution retirement plan. The latter might include a 403(b), the government TSP plan or a 457 if you are a teacher or in the government or non-profit sector.
As the Rolling Stones song goes, “Time is on your side.” This is an advantage Millennials have that others in the workforce don’t. Money invested today and over the next few years has years of compounded growth ahead of it. This isn’t to say the stock market will go up every year, but over long term the trend has been for gains. Money invested today can have 35 to 40 years or more to grow and compound.
JPMorgan Asset Management developed a graph illustrating this point.
- Susan invests $5,000 annually for ten years between the ages of 25 and 35 for a total investment of $50,000.
- Bill invests $5,000 annually for thirty years between the ages of 35 and 65 for a total investment of $150,000.
- Chris invests $5,000 per year for forty years between the ages of 25 and 65 for a total investment of $200,000.
Assuming a 7% annual return on their investments and no additional investment, at age 65:
- Susan will have amassed $562,683.
- Bill will have amassed $505,365.
- Chris, however, shows the ideal of investing for your entire career and will end up with $1,068,048.
This clearly shows the power of investing early and allowing the power of compounding to work for you.
Of course you will not earn a constant 7% or any other number each and every year, and your investments might lose money in some years. Nonetheless, time and compounding still work to your advantage.
The annual maximum salary deferral contribution allowed for your 401(k) is $18,000 for those under age 50. While this might not be attainable as soon as you start working, contribute something just to get into the habit. An increasing number of 401(k) plans will automatically enroll you at some minimum percentage of your salary, often in the 1% to 3% range. While you can opt out if you want, a better route to go would be to contribute more if you can.
If your plan offers a matching contribution, try to contribute enough to receive the full match. This is one of the few opportunities in life to receive free money. A common match in the corporate world is 50% on the first 6% of your salary that you defer to the plan. This works out to an immediate 50% return on your money. Hard to beat that!
Many plans offer a feature that allows you to increase the percentage of your salary you contribute each year. Take advantage of this even if you add just 1% annually. If your plan doesn’t offer this, plan to increase the amount of your percentage contribution each year on your own.
Invest for Growth
While nobody likes to lose money, at your age you shouldn’t be worried about the inevitable dips in the stock market. Invest for long-term growth, which means a focus on stocks.
If your plan offers target date funds, consider using the one with a date far out into the future like 2060 or 2055. Target date funds are not the be-all and end-all, but they do provide an instantly diversified portfolio for a new investor.
If you are allocating your money based upon the various investment choices offered by the plan, focus on stocks and look for low-priced index funds where possible.
An IRA can be a very effective savings tool for younger investors. Traditional IRAs have an income ceiling above which contributions cannot be made on a pre-tax basis if you are working and covered by a workplace retirement plan.
Roth IRAs also have income ceilings.
Younger workers may be earning under these levels and are in a unique position to take advantage of these savings opportunities.
For those of you who don’t have access to either a 401(k) or a similar retirement plan, an IRA is an excellent retirement savings tool.
Consider a Roth
If your company’s 401(k) offers a Roth option, you might consider this for some or all of your contributions. While the money contributed is done so after tax, younger workers are often in a lower tax bracket where the deduction is not worth all that much compared to the ability to withdraw funds tax free at retirement.
The same holds true with a Roth IRA versus a traditional IRA.
Manage Your Old 401(k)
Workers in general tend to change jobs a number of times over the course of their careers. It has been said this applies to Millennials even more so.
Even if your account balance is small, make a decision about your old 401(k) when you leave an employer.
Your options are:
- Leave it in your old employer’s plan. This can be subject to having a minimum account balance, so you will want to check on this. If your old plan is a good one with solid, low-cost investments, this might be a good option.
- Roll it over to a new employer’s plan, if allowed. This is a good option in terms of keeping all your 401(k) money in one place. You will, however, want to determine if the plan is a good one first.
- Roll it to an IRA. This is a good option in that you will have a wide array of investment choices available to you.
- Take a distribution. Young savers may want to avoid this, as you may have to pay a 10% penalty in addition to taxes. Also, this money is no longer working for your retirement.
For Millennials it is not too early to start saving for retirement. Take advantage of any employer plan available to you plus the long time horizon you have until retirement.