You did it. You landed the job. Exciting, huh? Along with the new responsibilities, business cards, and paychecks come a ton of files about all of the different benefits available to you. It’s time to start retirement planning.
It’s daunting, isn’t it?
As a recent graduate and new employee, you have several different retirement plans available to you. You may be tempted to ignore the issue for now, but that is a mistake. Starting to save early not only gets you into the habit, but it also helps your money grow over the decades between now and retirement. Some plans are offered by employers, others outside of the workplace. Many allow you to make choices of your investments.
You may be tempted to wait a few years, but you shouldn’t. It’s important to get into the habit of saving money. It’s even more important to take advantage of compound interest. “The most powerful force in the universe”, as Albert Einstein is rumored to have called it (http://www.snopes.com/quotes/einstein/interest.asp), compound interest is interest earned on interest. If you put away $100 this year at 8% interest, you’ll have $108 next year. In two years, you won’t have $116; you’ll have $116.64 because you earned interest on both the initial $100 investment and the $8 you earned in the first year.
That extra $0.64 isn’t a lot, but it’s more than zero. And, over time, the little extra adds up. With 8% interest compounded over 30 years, that $100 becomes $1006.27 – more than 10 times the original investment, with no additional contribution.
That’s pretty neat. And if you could put away just $100 each year, you would end up with $11,326.32 in 30 years.
Retirement plan regulations are set by the Internal Revenue Service. The IRS web site, https://www.irs.gov/Retirement-Plans, has thorough and detailed information, but here’s the simplified version: many employers offer a 401(k) plan, names for the section of the tax code that allows it. (Many non-profit organizations offer a similar plan, known as a 403(b) plan.) These plans allow you to take money out of your pay check before taxes, so your contribution costs less. Many employers will match part of your contribution. If yours does, this is free money that you receive simply for participating in the plan.
If your employer does not offer a retirement plan, you can open an Individual Retirement Arrangement, more commonly known as an IRA. The IRS allows for two types of plans, the traditional and the Roth. The traditional plan gives you a tax break now for contributions, and then you pay taxes on withdrawals in retirement. The Roth plan is not tax deductible, but withdrawals are not taxed. It also allows for more flexibility on withdrawals before you reach the age 59 ½.
Even though Roth plans and some types of employer plans allow for withdrawals or loans before retirement, your best bet is to pretend that you can’t touch the money. The tax penalties on early withdrawal can be high, it hurts your preparations for retirement, and it costs you the benefits of compound interest – the best reason to start saving now.
If your employer offers a retirement plan, the human resources department will have the information you need to open an account. In most cases, you’ll be allowed to choose from several different types of investments. That may be intimidating, but you can change to a different investment in the plan if you change your mind. Many plans have a target-date fund (https://www.ici.org/pubs/faqs/faqs_target_date), which is a mutual fund designed to meet the risk and return needs of people who have a given amount of time until retirement, and that’s usually a good place to start.
If your employer does not have a plan, then you can open an IRA through almost any bank, brokerage firm, or mutual fund company. As with an employer plan, it’s usually more important to start the process than to have the perfect investment because you can change it later.
When you first start working, you’re probably not thinking about retirement. You should, though, because small savings now will translate into big bucks when you’re ready to stop working.
