Katy Certified Financial Planner - Plan for Retirement - Starting at Age 20
You may shake your head at the idea of setting aside money for a retirement you won’t reach for another 30 to 40 years, particularly if you’re still paying off college loans, trying to save money for a home or just enjoying spending your first real paychecks. And your vision for retirement is probably hazy at this stage—but the advantages of saving for retirement are not. This is the perfect time to start a habit of saving for retirement because you have one huge advantage you’ll never get again….TIME.
The dollars invested early in your career will be worth far more when you retire, through the power of compounding, than the dollars invested closer to retirement. Say you begin investing in a 401(k) or similar tax-deductible employer-sponsored retirement plan at age 25 and invest $300 a month until age 65. If the account earns eight percent a year, you’ll earn $600,194 more by age 65 than if you wait until age 35 to start saving the same $300 a month.
So where can you start investing for retirement? Most likely, it will be through an employer sponsored retirement plan, such as a 401(k), that depends mainly on you having money automatically deducted from your paycheck on a pre-tax basis.
Try to put at least ten percent of your paycheck into the plan, up to the limit the plan allows. If ten percent is too much on a tight budget, a smaller percentage can still make a dramatic difference over time.
If the employer matches your contributions—say 50 cents or $1 for every dollar you put in—try to contribute at least enough to maximize the employer’s match—typically up to six percent of your salary. Saving six percent with a six percent matching means you immediately earn 100 percent return on your money!
What if your employer offers no plan? Your options are more limited. The only tax-deductible option is through an individual retirement account, and you can only put up to $4,000 annually into one in 2006 (up to $8,000 as a couple), with additional increases after that. But you can put unlimited amounts into after-tax choices including stocks, mutual funds and other investments.
If you’re self-employed, you have more tax-deferred choices, such as a simplified employee pension (SEP), Keogh plan, and for higher earners, a solo 401(k).
What types of investments should you choose? That depends on several factors, including your tolerance for risk, your overall financial situation, job stability and so on. In general, however, at a younger age you can probably afford to invest more aggressively than you would later in life, say most investment experts. You have the time to ride out the inevitable market downturns.
But as past market downturns illustrate, diversification remains key regardless of your age and tolerance for investment risk, particularly when it comes to company stock. As a general rule, we recommend keeping company stock to no more than 10 to 20 percent of your overall portfolio.
CAUTION: Young workers tend to cash out their 401(k) or other employer-sponsored plan account when they change jobs because the amounts are usually small and they want the money to buy a new car or other purchases. But you’ll pay income taxes and a penalty tax on the withdrawal. In addition, you’ll lose the ability for the money to grow tax deferred. So, roll it over into a self-directed qualified retirement plan.
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