A key rationale for founding Community Ladders was to get young professionals excited about saving for retirement through vehicles like IRAs and 401k’s. Simply put, saving earlier (even by a year or two) can have a profound impact on the amount of money you’ll amass by the time you retire. Einstein may or may not have said that ‘compound interest is the most powerful force in the universe.’ Nonetheless, saving whatever you can right now beats the pants off of saving quite a bit more down the road.
Here’s a simple illustration – if you invest $5000 at age 18 and earn just 5% a year (roughly half the historical return of the stock market) on it until you’re 72, you’ll have $69,693. Delay that investment 10 years, and you’d have only a bit over $40,000. Now, imagine you invested $5000 each year; you’d have $1.3 million. Delaying your investments 10 years knocks that down to below $800,000. That’s some powerful compounding and a compelling reason to get started NOW! [We must admit that, unfortunately, that $1.3 million is not going to have the same purchasing power as it does now, due to inflation. But you can still see the point and the awesome power of compounding!]
Now, how to get started:
Many employers will offer 401k (private companies) or 403b (non-profits) plans. This allows you to take money out of your paycheck and put it into an investment account. You don’t pay taxes on the money until you pull it out upon retirement. Many companies will match contributions you make, which is an AWESOME deal. In many cases it’s like earning an immediate 50% return on every dollar you put in. So much a fan of the employer match are we at Community Ladders, that even when people are saddled with loads of credit card debt we will often still contribute enough to a 401k in order to get the full company match.
You can also save for retirement independent of your employer, through Individual Retirement Arrangements (IRAs). These are investment accounts that you directly control. There are two varieties. The first, the Traditional IRA, is a pre-tax account. This means that you get a deduction on your taxes (subject to certain exceptions) for contributing to the account. You pay taxes on anything you withdraw from the account once you retirement. For young people, we are especially excited about the second kind – the ROTH IRA. This is a post-tax account, meaning that you pay taxes on your contribution now (think of it like you are taking money out of your wallet to fund the account). Any money you pull from the account upon retirement is TAX FREE. Young people often have lower incomes (so their tax rate is not that high) and they have decades to accrue gains on investments that will be tax free upon withdrawal. It is for these (and a few other) reasons that we are so excited about ROTH IRAs.
This blog entry is part of our June newsletter offering advice to recent graduates.
Bill Varettoni is a financial planner and the founder of Community Ladders.
This content was originally published here.