I imagine myself as the retiree (approximately 40 years from now) that spends her days at countless art gallery openings, seeing Broadway shows and taking daring and glamorous vacations to exotic places. Ah yes, time spent not only spoiling my dozens of grandchildren, but also gardening at the beach house and winning hand after hand of blackjack at the tables of Caesars Palace!
Turns out you need money to have a glamorous retirement. Actually, you need money to have any kind of retirement that includes food and shelter. Which leads me to the importance of saving for retirement.
A retirement account compounds with time. In other words, the longer you have it, the more money it will make. According to Bankrate.com if you begin saving for retirement at 25, putting away $2,000 a year for 40 years, you’ll have around $560,000, assuming earnings grow at 8 percent annually. If you wait until you’re 35 to start saving and put away the same $2,000 a year, but for three decades instead, and earnings grow at 8 percent a year, when you’re 65 you’ll wind up with around $245,000. That’s less than half the money.
They both still seem like kind of a lot of money, but let’s do just a little bit more math. Say I retire at 65 and assume I am going to have to live on that money for another 20 years. If I start saving at 25, that’s $28,000 a year. Not really enough to have all the glitz and glamour I was hoping for. If I waited until 35 to start saving, that’s only $12,250—just teetering over the poverty line for 2014 and that calculation doesn’t account for inflation.
I don’t mean to scare anyone. I’m just saying, to my fellow millennials, NOW is the time to start!
What about my savings account?
Savings accounts are great, but peel a few dollars away for the long haul. Money put into retirement accounts are taken pre-tax. That means you don’t pay tax on the money until you withdraw it. The theory is that in your retirement, you will be making much less than you’re making throughout your career. Meaning you will be in a much lower tax bracket and end up paying lower taxes on your money.
Here is a (very) high level look at a few different types of retirement accounts.
401(k) These are set up by your employer and they give you the option of choosing which accounts you would like your money to be invested in. A little bit of money is taken, before taxes, from each paycheck and goes into a series of accounts that fluctuate in value according to the market. This means you can make money on these accounts, but you can also lose money. You may be advised to put money in high or low risk accounts based on your age and your situation.
Find out if your company “matches”; many companies do. That means for every dollar you put in, your company will put in a dollar up to a certain amount. Say they match up to 3% of your income. Make sure you’re putting at least 3% into your 401(k) so you take full advantage of the perk your company is offering. And if your company does match, pat yourself on the back. It’s kind of like you just got a raise.
Here’s an example of how it could work
Say you make $50,000 a year.
You invest 3% a year into your 401(k). That’s $1,500.
You pay income tax after this deduction is made, so you’re being taxed as if you made $48,500. So your taxes are lower.
If your company matches the 3%, they kick in another $1,500 into the account. So you’re investing $3,000 a year.
403(b) This is very similar to a 401(k), and is offered for employees of the government and tax-exempt organizations. In other words, it’s the kind of retirement account your fifth grade teacher most likely had.
IRA (Independent Retirement Account) You can always open an IRA. It is not something that is run through your employer; you don’t even have to be employed. They are a way to save pre-tax money for retirement by investing them in stocks, bonds, and accounts (just like a 401(k)). There are some limitations; most people under 50 can contribute no more than $5,000 a year and you will face penalties if you withdraw your money before your retirement age, but this is the case for most retirement accounts. You can have multiple retirement accounts at once. So if your company offers a 401(k), you can still open an IRA. You can manage these on your own or with a financial advisor and open them online through a company like Vanguard or Fidelity.
Want more info?
I certainly don’t have all the info. Hopefully this was just enough to get you interested in researching for some more important details. Check out the CNN Money Retirement Guide. It answered a lot of the questions I had when researching for this blog and it’s pretty easy to understand.