You may shake your head at the idea of setting
aside money for a retirement you won?t reach for another 30 to 40 years,
particularly if you?re still paying off college loans, trying to save money for
a home or just enjoying spending your first real paychecks. And your vision for
retirement is probably hazy at this stage?but the advantages of saving for
retirement are not. This is the perfect time to start a habit of saving for
retirement because you have one huge advantage you?ll never get again?TIME.
The dollars invested early in your career will be
worth far more when you retire, through the power of compounding, than the
dollars invested closer to retirement. Say you begin investing in a 401(k) or
similar tax-deductible employer-sponsored retirement plan at age 25 and invest
$300 a month until age 65. If the account earns eight percent a year, you?ll
earn $600,194 more by age 65 than if you wait until age 35 to start saving the
same $300 a month.
Investment Opportunities
So where can you start investing for retirement?
Most likely, it will be through an employer sponsored retirement plan, such as
a 401(k), that depends mainly on you having money automatically deducted from
your paycheck on a pre-tax basis.
Try to put at least ten percent of your paycheck
into the plan, up to the limit the plan allows. If ten percent is too much on a
tight budget, a smaller percentage can still make a dramatic difference over
time.
If the employer matches your contributions?say 50
cents or $1 for every dollar you put in?try to contribute at least enough to
maximize the employer?s match?typically up to six percent of your salary.
Saving six percent with a six percent matching means you immediately earn 100
percent return on your money!
What if your employer offers no plan? Your options
are more limited. The only tax-deductible option is through an individual
retirement account, and you can only put up to $4,000 annually into one in 2006
(up to $8,000 as a couple), with additional increases after that. But you can
put unlimited amounts into after-tax choices including stocks, mutual funds and
other investments.
If you?re self-employed, you have more tax-deferred
choices, such as a simplified employee pension (SEP), Keogh plan, and for
higher earners, a solo 401(k).
What types of investments should you choose? That
depends on several factors, including your tolerance for risk, your overall
financial situation, job stability and so on. In general, however, at a younger
age you can probably afford to invest more aggressively than you would later in
life, say most investment experts. You have the time to ride out the inevitable
market downturns.
But as past market downturns illustrate,
diversification remains key regardless of your age and tolerance for investment
risk, particularly when it comes to company stock. As a general rule, we
recommend keeping company stock to no more than 10 to 20 percent of your overall
portfolio.
CAUTION: Young workers
tend to cash out their 401(k) or other employer-sponsored plan account when
they change jobs because the amounts are usually small and they want the money
to buy a new car or other purchases. But you?ll pay income taxes and a penalty
tax on the withdrawal. In addition, you?ll lose the ability for the money to
grow tax deferred. So, roll it over into a self-directed qualified retirement
plan.
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