The best time to start saving for retirement is when a worker joins the workforce. Workers can save for retirement through workplace retirement plans, individual retirement accounts, or both.
Understand the Power of Compound Interest
Due to the power of compound interest, workers who start saving for retirement in their 20s will have far more money saved than workers who begin saving in later in life. To illustrate, a worker at age 25 who saves $4,000 annually with a modest return of 5 percent has $496,183 saved at age 65. Another worker saves the same amount each year with the same return only has $272,897 at age 65 because the second worker started saving at age 35.
Workplace Retirement Plans
A 401(k) is a workplace retirement plan offered by a private company. Often the employee’s contributions to a 401(k) are matched by the employer up to 50 percent of six percent of the worker’s salary. Employees should consider contributing to a 401(k) until they reach the maximum amount their employer matches. A similar savings vehicle called a 403(b) is available to workers for public schools and nonprofits. Workers contribute to both vehicles with pretax dollars. Taxes are paid when the funds are withdrawn during retirement.
Individual Retirement Accounts
Contributions to a traditional individual retirement account (IRA) also are made with pretax dollars. Early withdrawals from a traditional IRA are subject to a hefty penalty from the Internal Revenue Service. A Roth IRA is funded with money that the worker has already paid taxes on. Early withdrawals of Roth IRA contributions aren’t subject to a penalty.
Be Aggressive at First
Workers in their 20s and 30s have a long horizon until retirement. They may want to put most of their savings into an aggressive asset like stocks during the early years. Stocks carry more risks than other asset classes. Over time, stocks usually provide a better rate of return than types of assets. Younger workers have the time for their stocks to recover from drops in the stock value.
Consider Target Date Funds
As workers get older, they should gradually decrease the portion of their retirement savings held in stocks in favor of less risky investments. Workers can keep rebalancing their retirement portfolios themselves. However, it’s easier to have a target date fund automatically rebalance asset allocation. Target date funds make a worker’s portfolio more conservative as the worker gets older.