The last thing millennials may be thinking about is retirement, but according to CPA and retirement expert Ed Slott, that should be the first thing on their minds.
People in their 20s and 30s “go through more life transitions than at any other age – you’re getting out of college, you’re graduating, you’re getting a job, you’re changing jobs, maybe you’re starting a business, you’re getting married, you have kids, you take on debt, you buy a home. All of these things are happening, and the last thing you’re thinking of is saving for retirement,” Slott says. “That should be the first thing.”
Slott shares four mistakes millennials make when it comes to retirement planning, and advice on how to get your finances in order as soon as possible.
MISTAKE #1: Not Starting Early
“The first mistake is not starting and not starting early,” Slott says.
Slott says people in their 20s and 30s are going through so many life transitions that they often wait to set up and contribute to retirement accounts until they feel more settled. But wasting the power of time is a huge mistake.
“The greatest money-making asset any individual can possess is time, and young people have more of it than anyone else,” Slott says. “You’ve got to capitalize on it.”
Slott explains that by contributing to a Roth IRA, a tax-free retirement account, you could have over a million dollars saved when it comes time to retire, all because of the benefits of time and compound interest.
“Let’s say you did nothing but put $5,500 in a Roth IRA. And that’s all you did. You made a habit every year of never missing a Roth contribution. If you did that starting at age 25 to 65, you’d have over a million dollars tax free for retirement,” he says.
But Slott explains compound interest works both ways: if you wait to start contributing at age 30, just five years later, you’d have about $200,000 less saved. “It adds up or it subtracts,” Slott says. “So you want it to work in your favor. Start early, make it a habit.”
MISTAKE #2: Not having a Roth IRA
Slott is a huge proponent of signing up for a Roth IRA, which offers tax-free growth and tax-free withdrawals in retirement, though you do pay taxes on the money you contribute. Roth IRAs come with income restrictions, but Slott says having one is a “slam dunk” for millennials, because your savings will continue to grow tax-free for the rest of your life.
“Tax free means you’ll never pay taxes on that money. That’s where you want to be in retirement, because it takes out the uncertainty of what future tax rates could do to your retirement savings,” Slott says.
Many employees may have the option to sign up for a 401(k), a retirement savings plan offered by an employer. But for those who don’t have a 401(k) option, they’re on their own when it comes to building retirement savings, and that’s where the Roth comes in.
Another mistake when it comes to an IRA is opting for the traditional IRA instead of the Roth IRA. While the traditional IRA gives you a tax deduction, Slott says it’s “worthless” for young people because they’re in a low income bracket and won’t benefit.
“If you take that deduction, you pay for the rest of your life. That account is growing tax-deferred – not tax-free. That’s a big difference,” Slott says. “Tax deferred means you won’t pay taxes on that money yet, but you will, and that’s not what you want in retirement.
MISTAKE #3: Raiding your retirement account
Slott explains that while retirement may seem far away now, dipping into your retirement funds before you’re actually retired is a huge mistake.
“I understand what people think – what if I need the money? But don’t think about it like that,” Slott warns.
When you sign up for a Roth IRA, you can access your funds at any time, without paying taxes or penalties. But Slott says those funds should be left alone.
“It’s very tempting to use this money, [but] it should only be used as a last resort,” Slott said. “It’s great it’s there but if you use it now, you won’t have anything for your retirement.”
And once saving becomes a habit and you see it grow, Slott says, you’ll be less likely to touch it.
MISTAKE #4: Cashing out your 401(k)
Most people don’t stay at the same job for their entire career, and Slott says forgetting about your 401(k) or cashing it out when you switch jobs is a huge financial mistake.
Even if you only have $1,000 in your 401(k), don’t cash out. You’ll pay taxes and a 10% withdrawal penalty. That $1,000 adds up to a lot more in lost earnings, he says.
Slott says you should convert those funds into an IRA, where you’re no longer dependent on an employer-sponsored savings plan.
While Slott encourages millennials to do as much as they can to save for retirement early on, he also advises savers to be careful about going overboard: “I always say, small steps equal big victories. You can’t take on too much, because you have to live, you have to eat, and if you overdo it, you won’t stay on track. So do what you can do.”