If you’re in your 20s or 30s, you’re probably facing plenty of financial pressures. There are the weddings, cars, and kids. Perhaps you’re buying your first home or launching a business. And of course, there’s student loan debt.
At the same time, since you’re just starting out in your career, your earnings may be on the lower side. Millennials, in particular, have struggled with depressed wages, as many graduated into an economy in recession.
With all the demands on your pocketbook today, it may be tempting to put off saving for retirement. In fact, two-thirds of millennials—or people between the ages of 21 and 32—who are working have saved absolutely nothing for retirement, according to a recent report from the National Institute on Retirement Security. And only five percent are saving as much as most experts say they should.
Even though it seems like your Golden Years are far away, there are many reasons to start saving now. Thanks to rising life expectancy, you will likely spend much longer than your parents and grandparents did in retirement. A 25-year-old woman today has a 50% chance of living to age 90, and a man of the same age is expected to live to nearly 87.
At the same time, fewer young people have access to pensions and employer-sponsored plans, and the future value of Social Security benefits is uncertain. If you spend 30 years in retirement, you’ll need to save an estimated $1.2 million to live on $40,000 a year. Unless you plan to work long after your hair turns gray, you’ll need to start saving ASAP.
The earlier you start building your nest egg, the more your savings will grow. Thanks to the power of compound interest, the length of time your money spends in the stock market plays a huge role in the amount you end up with.
For example, a 25-year-old would have to save $5,356 every year, at an estimated return of 6%, to retire with $1 million at age 67. Someone who starts saving at age 30 would need to put away $7,413 per month. And a 40-year-old who makes $60,000 would need to save 25% of every paycheck!
How To Start a Retirement Plan
Once you’re convinced you need to start saving for retirement, you might find it daunting to figure out your first steps. Start by calculating how much you need to save. To do this, you need to ask yourself a few questions:
What is your target retirement date? Do you plan to stop working at age 65, or will you continue working full-time or part-time?
Based on current life expectancy, how many years to you plan to spend in retirement?
What kind of lifestyle would you like in retirement? Do you expect your expenses to be higher or lower than today?
Once you’ve considered these questions, consult a retirement calculator. This tool will help you figure out much you need to sock away, given your age, how much you’ve already saved, and other factors. A common rule of thumb is that you should have the equivalent of your yearly salary saved by age 30 and twice your annual salary saved by age 35.
Choosing the Right Retirement Plan
Once you know how much you should be saving, consider opening a retirement account. It might not make any sense to keep your money in a savings account, since you don’t need to access it for decades and you’d lose out on the chance to grow it through investment.
There are several types of retirement accounts to choose from, all of which allow you to invest your funds in a variety of assets. The one you should pick depends on your personal situation:
A 401(k) is an employer-sponsored retirement plan (it’s called a 403(b) if you work for a non-profit). If your workplace offers this type of plan, many employers offer to match your contributions up to a certain amount.
A 401(k) also has a higher contribution limit than most other plans (the maximum is $19,000 in 2019 ). Another benefit is that you can automatically have contributions deducted from your paycheck, which makes it more likely that you’ll stay on track. Like most of the plans listed below, a 401(k) is tax-advantaged, meaning you can reduce the amount you owe to the IRS.
While a 401(k) is offered through an employer, you open an IRA, or an Individual Retirement Account, on your own. Compared to a 401(k), an IRA usually offers a wider variety of investment options and allows you to select institutions and funds with lower fees. There are several types of IRAs:
A Traditional IRA lets you set aside up to $6,000 a year in pre-tax dollars. You pay taxes on the money you withdraw in retirement. If you withdraw funds before age 59½, you will pay a 10% penalty . There are exceptions for first-time home purchases, qualified educational expenses, unreimbursed medical expenses, and a few others.
Once you turn 70½, you are required to withdraw a minimum amount every year or pay a penalty. Financial professionals often recommend a traditional IRA for people who expect to be in a lower tax bracket when they retire, or for those who tend to owe a lot on their taxes.
A Roth IRA allows you to contribute up to $6,000 a year in post-tax dollars. You can withdraw the contributions (but not earnings) without penalties or taxes at any time. You can take out your earnings without paying a penalty for certain reasons, such as financing your first home or paying for medical expenses.
You don’t pay taxes on the money you withdraw in retirement, and there are no required distributions. You must fall below the income limit ($122,000 for a single person, or $193,000 for a married couple filing jointly, in 2019) to contribute the maximum amount to a Roth IRA. Consider a Roth IRA if you are likely to be in a higher tax bracket when you retire or if you usually get a refund at tax time.
A SEP IRA is designed for people who are self-employed or own small businesses. It’s similar to a traditional IRA, your contributions are tax-deductible. But you can often contribute much more than to a traditional IRA. In 2019, you can put in up to 25% of your income, or $56,000, whichever is lesser.
Using Brokerage Accounts in Retirement Planning
You can also save for retirement using a general investment account. While this won’t have the same tax advantages as a retirement account, this is a good option if you want to contribute more than annual limits allow or take advantage of other benefits. Unlike retirement accounts, general brokerage accounts don’t have limits on how much you can contribute or when you can take money out.
SoFi Invest®, for example, allows you to invest in Exchange Traded Funds (ETFs), which are mutual funds that offer a diversified mix of stocks and bonds at low fees. Diversification across thousands of assets reduces, but does not eliminate, your risk, and your portfolio is rebalanced once a month to keep it in line with your investment goal and risk tolerance.
Investing Toward Retirement
Once you’ve selected a retirement plan, you have to put the money to work for you by investing it. The portfolio you choose depends on your age and your risk tolerance, among other things. Generally, if you’re younger, you want to opt for a more aggressive strategy that includes a higher share of stocks.
This has the potential for higher returns but gives you time to bounce back from any market downturns. If you’re older or more risk-averse, you would go for a more conservative strategy with a greater share of bonds. A financial planner can give you guidance on the mix that’s right for you.
You also have the choice between passively and actively managed funds. Passively managed funds, usually index funds or ETFs, track the performance of a certain index, such as the S&P 500. Actively managed funds are those that try to do better than the index based on research and predictions.
Passively managed funds usually offer lower fees than actively managed portfolios. An automated SoFi Invest account falls somewhere in the middle. It allows you to invest in passively managed index ETFs, but professionals actively manage the ETFs in your portfolio and recalibrate based on new market data, as well as your risk tolerance and individual goals.
Choose how you want to invest.
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