So you haven’t reached the big 3-0 yet? If your worst fear is turning 30, then imagine how you will feel when you turn 60. Now, top that off with having a less than stellar retirement fund. One of the great things about being young is that you can start funding a retirement fund that will continue to grow for at least the next 30 years. This may seem like a long way off, but waiting to contribute to your retirement fund could cost you a lot of money in the end, and possibly change the lifestyle that you want to live when you choose to retire. By choosing to invest in a retirement fund at a young age you can take advantage of things like company matched contributions and compounding interest, which can play a big role in the size of your retirement funds when you are ready to stop working.
Retirement Fund Options
What is a 401(k)? A 401(K) retirement fund is something that your employer might provide, and if they do it is worth looking into. Before you jump in there are some things you need to consider. First, find out what the maximum contribution is that you can make to your 401(K). Then, take this number and divide it by the number of paychecks that you get. Most employers will remove your 401(K) contributions from your paycheck and have them put into your account. If you can afford the maximum, go ahead and do it. If not, then find the number that matches your budget.
Find out if your employer will match your contributions. There are a lot of companies that provide some sort of matching when it comes to their employees 401(K) contributions. This is basically free money. For every dollar that you contribute your employer could match it. If your employer does offer matching, then look into it and find out the exact details.
Most of the time the money deposited into your 401(K) account is tax deferred. That means, you will not pay any taxes on it until you start to make withdrawals and you can deduct your contributions from your yearly taxable income. This could be beneficial if you are on the border line of a tax bracket and you could use your 401(K) contributions to get you into a lower one. If you need to withdraw any money from your 401(K) account before the age of 59 ½ you will have to pay a penalty on top of the taxes that you will pay on the money that you are withdrawing.
A traditional IRA (individual retirement account) is an account that you set up and you can manage or pay someone to manage it for you. Therefore, you can choose where to make your investments. A traditional IRA allows you to make contributions and deduct them from your taxable income. Just like a 401(K), this could be beneficial as your contributions will save you a great deal in taxes at the end of the year. By doing this you are deferring the taxes paid on this money until you start to make withdrawals. Once you retire and decide to use the money in your traditional IRA you will pay taxes on it as if it is income that you are receiving. This will also determine which tax bracket you are in. If you are in a high tax bracket now and think you will live a simple lifestyle when you retire, then a traditional IRA might be the way to go. If you are under the age of 59 ½ and you need to withdraw money from your traditional IRA, you will pay taxes on the money that you are withdrawing, plus a 10% penalty. Point is, you want to make sure you do everything you can to keep your money in your traditional IRA until you turn 59 ½.
The main difference between a Roth IRA and a traditional IRA is when you will pay taxes on the money that you put into your account. With a Roth IRA you cannot deduct your contributions from your yearly taxes. You will pay taxes on that money based on what tax bracket you are in. But when you decide to withdraw your money for retirement, you do not have to pay any taxes because you have done so already when you made your contribution. It is hard to determine which tax bracket you will be classified in when you retire based on the money that you are withdrawing. If you think you will be in a higher tax bracket during retirement than you are right now, then a Roth IRA is a good choice. This way, you will pay less in taxes now, than you will when you are making withdrawals. Each year the rules for Roth IRA contributions are likely to change, so make sure you know what they are before setting one up. Also, because you have already paid the taxes on the money that you are contributing, you can withdraw whatever you have put in penalty free. However, if you start to withdraw gains that your Roth IRA has made, you will likely pay a penalty and taxes on those.
Setting up for your retirement at a young age is a strange thing to do because it seems so far away. Yet, when the time comes to retire you will be glad you did based on the amount that is in your account. By taking advantage of compounding interest, your retirement fund will be set up to grow much more because you invested in it early. You will also have a lot more to live off once you retire.
At a young age many people might ask the question, what is retirement? Now that you know you can have the dream of retiring one day and be able to do the things you want. By setting up your retirement fund early (whichever one it may be) you will be on your way to making that dream come true.