The Benefits of Retirement Savings for Young Adults
If you are a young adult graduating from high school or college and entering the workforce, you may have the opportunity to open a 401(k) through your new employer. In some cases, that employer will also offer matching contribution funds up to a certain percentage. While it sounds like a no-brainer to take advantage of these benefits early, less than one-third of employees ages 25 and younger participate in their employer’s 401(k) plan.
It’s essential to know the benefits of investing early and often, as it can help set you up for financial success in the future. Or, if you're the parent of a young adult, it may be beneficial to have a conversation with them about starting their savings, even though they are a long way from retirement. Here are some key benefits to starting to invest in a 401(k) or other retirement plan in your early 20s.
Retirement Plans Offer Tax Breaks
One of the most important reasons to start investing in a retirement plan early is the tax breaks that come with it. Every young person remembers the feeling of getting their first pay stub and seeing a large percentage of their pay taken out for taxes. By investing in a 401(k), you can save money before those taxes are taken out. The money you put away now will accrue interest, and will not be taxed until you begin taking distributions from your account during retirement.
Alternatively, your employer may offer Roth 401(k) contributions. This allows you to save the money after-tax, as you're likely in a lower tax bracket at the start of your career. Roth funds allow for tax-free growth and tax-free distributions in retirement. With the benefits of compound interest and earnings, Roth funds that are saved early in your career may more than double or triple by retirement - at which point, all that growth will be available as tax-free retirement income.
Potential Employer Contributions
Another incentive of investing in a 401(k) from a young age is employer contributions. Every employer is different, but many will offer some type of matching contribution for those who choose to participate in their sponsored retirement plan. Employer contributions are essentially “free money” for your retirement savings.
Say your employer will match contributions one-to-one for up to 4% of their paycheck—anything they contribute up to 4% will be doubled. In this scenario, you should aim to contribute at least 4% of your paycheck in order to take full advantage of what many people consider to be “free money.”
Not only is opening a 401(k) a smart idea, it’s also very easy to contribute to one. Contributions are taken from your paycheck and deposited directly into your retirement account. If you start saving early on, you probably won’t even notice a difference in your take-home pay. Most 401(k) plans also make it easy to automatically increase contribution rates each year—something that many financial professionals suggest to effectively compound retirement savings.
Comfort in Retirement
Lastly, the earlier you start to save, the more likely you'll be able to comfortably retire when you get older. Compound interest builds over time, so the longer their account is open, the more you will have earned in capital gains. And starting now will allow you to build a good habit of saving a little bit every month. Even if you stop contributing because of unemployment or financial strain, the money they’ve already invested will continue to grow.
For an example of compound growth, let's look at two individuals; one who saved $100/month at age 25, and the other who saved $100/month at age 35. Both grow at a rate of 6%, and both individuals want to retire at 65. Over the course of one year, they each saved $1200.
$1200 in savings at age 25: $12,342.86 at age 65
$1200 in savings at age 35: $6,892.19 at age 65
As you can see, giving your money an extra 10 years to grow may nearly double the amount that you have at retirement. Starting early allows your money to work harder for you, improving your retirement outlook.
Alternative Options for Retirement Plans
If your employer doesn’t offer a sponsored 401(k) plan, you should consider an IRA plan instead. IRA plans offer similar benefits to traditional 401(k)s—they grow over time, can take automatic contributions from a checking account, and involve tax benefits. You can choose from a traditional pre-tax IRA or a Roth IRA.
Since these are independent plans, you can keep them open even if you start a new job that offers a 401(k). Many financial professionals even recommend keeping retirement savings in more than one type of account.
Whatever career path you choose, saving for retirement is an important step in your adult life.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2020 Advisor Websites.