As a new graduate entering the workforce, your retirement 40-plus years from now probably isn’t top of mind. But if you have dreams of becoming financially independent early, or if you want to start building a million-dollar retirement fund, making one smart move this summer can transform your future.
Open an IRA.
An individual retirement account, or IRA, is a great way to start investing for the future. About a third of private sector employees work for a company that doesn’t offer a retirement plan like a 401(k), according to Pew Charitable Trusts. Even if your new employer does offer a 401(k), new hires often don’t have access to it. About 4 in 10 companies impose a wait of three months or more before you can start contributing, according to data from the Plan Sponsor Council of America. That includes 13% of companies where you’ll have to celebrate your one-year work anniversary before you can start saving.
Good news: It takes just a few minutes to open your own IRA, and having one can help set you up for financial freedom later. Here’s what you need to know.
How investing early puts you ahead
“Time is a special thing, and you can stack the deck in your favor for retirement by having time on your side,” says Jason Escamilla, chief investment officer of ImpactAdvisor in San Francisco. “It’s not just the discipline of investing but putting a long time horizon on your investment planning.”
Even small amounts invested will multiply thanks to compound interest, where you earn on both the money you deposit and the interest it accrues.
“The earlier you start saving, the more you get the benefit from the power of compounding interest,” says John Campbell, senior vice president and managing director of wealth planning at U.S. Bank Private Wealth Management.
To appreciate just how powerful this is, consider the classic example below from the Federal Reserve Bank of St. Louis. The saver who starts earlier ends up with a bigger savings balance at age 65, even though her friend who starts later puts aside three times as much money.
How to pick an IRA
Even if you can only contribute a few hundred dollars this year, it’s still worth opening an IRA, and most banks don’t require a minimum amount to do so. A few things to know:
You can contribute up to $6,000 in an IRA for the 2019 tax year. Workers age 50 and older can put in an extra $1,000, or $7,000 total.
You can’t contribute more than you earned in the year, though.
You have until April 15, 2020, to make contributions for the 2019 tax year.
To get closer to the maximum you’re eligible to contribute, you could use money you received for graduation or ask your parents if they might be willing to match your IRA contributions, Campbell suggests.
There are several types of IRAs, but the most popular are the traditional and Roth. Check out our explainer comparing the two, here. One big difference is when you get a tax break:
Now for the traditional IRA. Your contributions are tax-deductible when you make them, and, eventually, withdrawals will be taxed.
Later with a Roth IRA. Your contributions are made after taxes, but withdrawals in retirement aren’t taxed.
“If you think you’re in a lower tax bracket today versus what you’re going to be in down the road, then the Roth makes a whole lot of sense,” Campbell says.
There is an income cap on Roth IRAs you’ll want to watch out for as you advance in your career. You don’t qualify to make contributions if your adjusted gross income as a single taxpayer is more than $137,000.
But as a new grad, it’s likely you’ll be in a lower tax bracket now than later in life—so the Roth can be an especially smart move. If you deposit money in a savings account, you’ll be taxed on the interest you earn; money in a Roth IRA can grow tax-free.
“Every dollar makes a big difference,” Escamilla says. “Not only are you helping yourself this year, but in future years.”
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June 4, 2019