Retirement Investing for Beginners
This is going to be the first in a series of investor articles, aimed at helping individuals prepare themselves for a financially-secure retirement. When we talk about beginners, we're talking about individuals that are just starting their careers, and have considerable time before reaching retirement age.
The focus of this topic will be individuals that are under the age of 30, and the strategies they can use to build a financially-secure retirement. To some it might seem like a strange idea to discuss retirement planning for workers with 30 or 40 years to go in their careers.
Retirement Strategies for the Young
This group has considerable time on their side. These are young people, just starting their careers, with the opportunity to put into place a retirement plan that is relatively painless. This is something that can quickly pass by those that procrastinate, since it's a relatively short window of opportunity.
Compounding Interest and Earnings on Earnings
Younger individuals have the power of compounding of interest, earnings-on-earnings, on their side. They have the time to see how $10,000 invested today can grow to be worth $100,000, or more, at retirement. By recognizing early in a career that beginning a retirement plan is an important long-term strategy, a lot of anguish is saved later on. Anyone waiting until age 50 to start a retirement plan, can be certain of one fact: It will be financially painful.
Expensive Life Events
Retirement is just one of life's events that need to be considered when evaluating one's overall financial wellbeing. There are events in life that are also worth considering when financial planning.
- Marriage: many individuals eventually get married, and that can be expensive. Even a relatively "modest" wedding and reception can cost over $10,000. In fact, research conducted by The Wedding Report indicates the average wedding cost over $26,000 in 2012.
- Children: many people also have children, and these little friends are also expensive. The rule of thumb is that it costs roughly $250,000 to raise a child from birth to age 18. That number only includes housing, transportation, childcare and food.
- College Education: in addition to feeding and sheltering a child, they might one day go off to school. The average cost of a private education is roughly $196,000. For a public education, it's closer to $88,000 (tuition and fees only, including room and board in 2020).
There are certain life events that are expensive. In fact, the above examples are only half the story, because this list didn't even talk about expenses like paying for a child's wedding, buying or leasing cars, paying back school loans, or buying a home.
Life is wonderful, and like many things, retirement is a pay me now or pay me later arrangement. It's easier for many individuals to address their immediate financial needs, and worry about the future, like retirement, later on. But we can guarantee one fact: Planning for retirement now makes the financial burden later on less stressful.
Beginners looking for ways to save for retirement have many options because they don't need to be as aggressive when putting money away. We talk about this more in-depth in: Retirement Planning in Your 20s. That article even provides some examples demonstrating how helpful it can be to start saving early.
Whether young or old, planners have multiple options when it comes to retirement funding. The two programs that are universally available include:
- Traditional and Roth IRAs
- Social Security
Depending on the employer, it's even possible to have these additional retirement account options:
- 401(k) Plans, as well as the Roth 401k
- 403(b) Plans, as well as the Roth 403b
- Traditional Pension Plans
We're going to discuss each of these plans, talking about each in the order of preference. For example, 401(k) / 403(b) plans will be mentioned first, because employer matching usually makes these types of plans the most desirable first-stop for a retirement fund.
401(k) and 403(b)
If an employer offers a 401(k) plan or a 403(b) plan at work, this is typically the best place to start retirement savings. One of the nice features of these plans is they provide a tax shelter. The money placed into the plan is normally on a pre-tax basis. Employers oftentimes match employee contributions to increase plan participation, providing an instant return on investment for the money contributed to the plan.
In 2006, many companies introduced the concept of a Roth 403(b) or Roth 401(k) plan. While the money placed into these accounts is on an after tax basis, all withdrawals, including growth in the account balance, are made on a tax-free basis.
The next funding option should be IRAs. In particular, Roth IRA plans can be a great way to save for retirement. The money that goes into the plan is after-tax, but withdrawals are tax-free. Just a word of caution; there are many IRA rules and contribution limits that apply. That being said, IRA plans can prove to be a great source of retirement income.
Pension plans today are getting more complex. There are employee-funded pensions (defined contributions) and traditional pension plans (defined benefits). Individuals that work for the same company for many years are often rewarded with a pension that can be a significant source of retirement income.
Relying on Social Security is not a good idea for anyone under age 30. While many politicians will promise that Social Security will be around forever, the future of that program remains uncertain. Until that debate is settled, a backup plan is needed; just in case Social Security disappears.
Retirement Planning Spreadsheet
Finally, we've put together a simple retirement planning spreadsheet that can be downloaded for free. There are several simplifying assumptions on that spreadsheet. The best way to use that tool is to run through some "what if" scenarios.
For example, one scenario might involve the lack of Social Security as a source of retirement income. It's also possible to see the impact 401(k) plans and IRAs can have on retirement income, and the level of funding needed to produce a given level of income.
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