Most new college graduates aren't thinking about their eventual retirement from the workforce. But the financial decisions you make at a first job can set you up for a lifetime of financial success and a comfortable retirement. Here's why you should begin saving for retirement with your first paycheck:
401(k) match. A 401(k) match is likely going to provide the best return you can get on an investment. If your employer offers a 50 cent contribution for each dollar you save up to 6 percent of pay, you will get a 50 percent return on that investment, not including investment gains. If you save $1,000, you will get an extra $500 from your employer. "You want to join as soon as you can, and you want to contribute as much as you can," says Patricia Humphlett, coordinator of the Labor Department's retirement savings education campaign. "But if you can't afford to contribute the maximum, try to contribute enough to get as much of that employer match as you can. This is free money."
Compound interest. Putting money into a retirement account at an early age gives it more time to grow. The results of compounded investment gains can be impressive over a 40-year career. If you save just $2,000 per year beginning at age 22, you will have over half a million dollars by age 65, assuming 7 percent annual returns. And if you received an employer match on that $2,000, you would have nearly three quarters of a million by age 65. If you wait until age 35 to start saving, you'll have to save over $5,000 per year to hit half a million dollars by age 65. Wait until age 45, and you will need to save around $12,000 per year to get the same result. Beginning to save early means you can save smaller amounts and let the interest on your investments do the rest of the work. "If you can get critical mass early in life, then everything is going to be a lot easier later on in life," says Charles Ryan, a certified financial planner for Atlantic Financial Planning in Annapolis, Md. "The portfolio is doing most of the heavy lifting."
Tax savings. Saving for retirement in a traditional 401(k) or individual retirement account lowers your tax bill each year. For someone in the 15 percent tax bracket, putting $5,000 in a 401(k) or IRA will save you $750 on your current tax bill. If you're in the 25 percent tax bracket, the same contribution will save you $1,250. Income tax won't be due on your contributions until you withdraw the money, and it can be deferred until age 70½, at which time withdrawals become required.
Roth option. Young investors with low incomes also have a lot to gain from investing in a Roth IRA or Roth 401(k). Roth accounts allow you to pay income tax at your current rate, and then withdrawals from accounts that are at least five years old will be tax-free in retirement. "If I was in the 15 percent tax bracket, I would probably save through the Roth," says Edward Fulbright, a certified public accountant for Fulbright and Fulbright in Durham, N.C. "If I am in the 25 or 28 percent bracket, I would probably contribute to the deductible IRA, and I would just base it upon what my tax bracket is."
Saver's credit. Workers who earn small salaries at their first job but still manage to save for retirement may additionally be able to claim the saver's credit. Individuals with an adjusted gross income of less than $30,000 in 2014 who contribute to a 401(k), IRA or similar type of retirement account are eligible for a tax credit equal to 50, 20 or 10 percent of the amount contributed up to $2,000, with the biggest credit going to those with the lowest incomes.
Automatic withholding. One of the most valuable features of 401(k) plans is that the money is withheld from your paycheck before it ever hits your checking account, so you're never tempted to spend it. "Getting motivated to save for something that will happen 25 or 30 years from now is tough," says Nancy Register, associate director of the Consumer Federation of America. "Virtually every successful savings plan includes an automatic component." If you don't have a 401(k) account at work, you can recreate this effect by directly depositing a portion of your paychecks into an IRA, savings or investment account.
More From US News & World Report
- How to Max Out Your Retirement Accounts in 2014
- What Everyone Should Know About IRAs
- 10 Trendy 401(k) Plan Perks
- Personal Finance - Career & Education
- Retirement Benefits