Building Retirement Savings at Any Age: Part One of Three
In Your 20s and 30s:
Start Saving Early.
Time is the greatest ally you have when saving for retirement. Why is that? The longer your savings have to compound, the less money you may need to contribute to reach your retirement goal. For example, while someone in their twenties may be able to reach their goal by contributing 10% to 15% of their income each year, someone who begins to save in their forties may need to contribute 30% to 35% of their income each year to potentially reach the same goal. So starting to save early may be far easier for you in the long run.
Take Advantage of the Retirement Plan at Work.
If your employer sponsors a retirement plan, such as a 401(k), it is usually a good place for you to begin saving for retirement. Here’s why.
- Having your employer automatically deposit part of every paycheck directly into your retirement account is convenient.
- Your investment earnings are not taxed while in the account, which helps your savings grow faster than in a taxable account.
- Your contributions can be made with pre-tax money, which reduces your current income taxes.
- Your employer may match a portion of the money you contribute.
Contribute to an IRA.
As long as you, or your spouse if you file joint tax returns, earn taxable compensation, you can contribute to an individual retirement account (IRA) and potentially reap tax benefits similar to those offered by workplace retirement plans. Like workplace plans, your investment earnings are not taxed while in an IRA. And if you choose a traditional IRA, your contributions may be tax-deductible, which would lower your current income taxes. (With a traditional IRA, your investment earnings and deductible contributions will be subject to income tax when withdrawn from the account.)
Consider a Roth Account.
With a Roth account, your contributions are made with money that has already been taxed and your contributions are not tax deductible. But from then on, it can be tax- free sailing- no tax on your investment earnings while in the account and no tax on your withdrawals, as long as you follow the rules for Roth accounts. A Roth account can be a good choice for younger individuals who have decades to potentially benefit from tax-free compounding before they will need their money. It can also be a good choice for individuals at the start of their careers because it enables them to pay taxes now when their income and income tax rate may be lower than it will be in retirement. Roth accounts are offered by some 401(k), 403(b), and government 457(b) retirement plans. You can also open a Roth IRA on your own, provided your income is below certain limits.
How you divide your portfolio among stocks, bonds, and cash investments can have a big impact on your returns. In general, the higher an investment’s risk, the higher its potential return.
- Stocks carry the most risk and have historically provided the highest returns over the long term.
- Bonds have less volatility and less chance of losing the amount invested and have historically provided lower returns than stocks over the long term.
- Cash Investments have the least degree of risk and have historically provided the lowest return of the three asset classes.
With decades to go before you retire, stocks with their potential for higher returns over the long term may have an important role to play in your investment mix. Just how large a role they should play will depend on your tolerance for risk, your investment objectives, and how much time remains before you will need your money. Your financial advisor can help you decide how to allocate your investments among stocks, bonds, and cash at this point in your life.
Please note that asset allocation does not ensure a profit or protect against loss in declining markets.