Nearly two million Americans will graduate from college with an undergraduate degree this year, and most of them will enter the workforce rather than continue on to a graduate degree. As these twenty-some things begin earning wages from “real jobs” for the first time, many overlook the need to start saving for retirement. However, saving early is more important than ever. According to the Wisconsin Banker’s Association, pension plans are becoming increasingly rare and Americans are living an average 22 years longer than they did when Social Security was created in 1937. Therefore, today the youngest members of the workforce are largely responsible for their own retirement income.
Here’s a quick overview of the most common investment accounts used to save for retirement:
IRA – If your employer doesn’t offer a company retirement plan, start your own nest egg by opening an Individual Retirement Account (IRA). These accounts provide tax advantages that a regular savings account does not. The maximum contribution to an IRA is $5,000 per year if you’re under age 50 and $6,000 per year if you are over age 50. The money in IRAs is invested by the company managing the account and it is also easier to withdraw from than a 401(k). However, because this is a retirement account, there are still taxes and penalties associated with withdrawals before age 59 ½.
401(k) – This type of retirement savings account is directed by employers and contributions are deducted from paychecks, before taxes. The account is then taxed when a withdrawal is made after age 59 1/2. The current maximum annual contribution to a 401(k) plan is $17,000. Also, many employer plans include a matching contribution, which is money that the employer will contribute to the account if the employee contributes as well. For example, if the company you work for has a program where they will match 50 percent of your contribution up to 3 percent of your paycheck, if you contribute the full 3 percent, you’ll receive an additional 1.5 percent from your employer. That’s free money for your retirement!
Roth vs. Traditional – There are different types of IRAs and 401(k) plans, with the most popular being Roth and Traditional. The basic difference is when the owner pays taxes on the account. With a traditional retirement account, the money goes in before taxes and then taxes are paid when the money is withdrawn. With a Roth account the money contributed is after tax money and you pay no taxes when you take it out. Both accounts offer tax deferred growth. Roth accounts are especially valuable to young workers, as they are more likely to climb into higher tax brackets as they age, meaning they would owe more in taxes on the same amount of money later in life.
Notice that keeping cash under your mattress isn’t on this list. Money that isn’t invested or placed in a bank account earns no returns or interest. Make your hard-earned money work for you by investing in an IRA or 401(k).