If you're still looking for that first job after graduation, saving for retirement may be the last thing you want to think about. But, it's actually one of the best things you can do for your future finances, even if you'll want to spend every penny of your first few paychecks and know you won't be retiring for four more decades.
The earlier you start a retirement fund, the more time you'll have to allow the magical forces of compound interest to multiply your money. For example, if you invest $200 a month starting at age 22, and you end up with a return of 8% annually (this will vary based on market conditions), after 38 years, when you're 60, you will have $532,483.22. If you wait until you're 30 to start making that investment, you’ll only have $273,892.24. That’s a pretty substantial difference. You can use a simple savings calculator to figure out the implications of starting to save earlier. Even while you're still in the thick of job hunting, you have options for starting a retirement account.
Here are three ways you can start saving for retirement:
1. Individual Retirement Account (IRA)
You can open an IRA as long as you have earned income that you report on your federal income tax return. Yes, those odd jobs that pay the bills count while you pull together your resume!
- With a Traditional IRA, you get a tax deduction when you contribute to the account, and any interest you earn is tax-deferred. For example, let's say your income for the year is $35,000 and you put $2,000 into your IRA. The tax deduction means you only have to pay taxes on $33,000 of your income. The tax-deferred earnings mean your IRA money keeps earning interest, but you don't pay taxes on your earnings until you start withdrawing IRA funds after you retire.
- You can also open a Roth IRA, which does not give you the initial tax deduction, but the earnings on that money grow tax-free. In other words, when you withdraw money from a Roth IRA after you retire, you don't pay taxes on the earnings, since you paid the taxes up front on the income.
- For the self-employed, there are other types of IRAs, including SEP and SIMPLE IRAs.
- When you're married and earn income, your spouse can open an IRA even if he or she hasn't earned any income.
One of the benefits people seek when they look for a job is a 401(k) retirement plan. You can contribute to a 401(k) by having a percentage of your income deducted from your paycheck, and you pay no taxes on what you deduct.
- Many companies also offer a match, meaning they will match a portion of your 401(k) contribution with their own funds. This is considered free money that goes into your retirement account to help you build your nest egg faster.
- A 401(k) might also come with a Roth option, and some employers offer IRAs.
- If you're self-employed, you can open a Solo 401(k).
3. Taxable Accounts
If you, for some reason, don’t qualify for a tax-advantaged retirement account but have some money not considered earned income (possibly a graduation gift), you can invest it using a taxable account. Some online discount brokers will allow you to start with as little as $50, and add as little as $25 a month. The important thing is to get started and develop a habit of saving now, while you're fresh out of school. You'll likely earn interest at a greater rate with a taxable investment account than with a more traditional savings account. The interest you earn on these accounts is called capital gains, and you'll have to pay capital gains tax when you sell your shares. Depending on your tax bracket, your long-term capital gains might be taxed at a lower rate than your income is. (If you sell your shares in less than a year, your earnings will be taxed at your regular income tax rate.)
Bottom Line: Start Saving!
The important thing about saving for retirement is to get started. You don't need a large lump sum; you can open an IRA with only $25 to $50, plus regular, small monthly investments. If you have money automatically taken out of your paycheck, you can start with a small amount. Automatically investing is a good way to get in the habit of setting money aside. As your ability to invest more increases, you can contribute more to your retirement account.
It may seem silly to start a retirement fund when your career is in its infancy. But developing the habit is more important than how much you can contribute. Even starting a retirement fund 10 years from now can mean a difference of tens of thousands, possibly even hundreds of thousands of dollars, when you do retire. So, the earlier you start to build a retirement fund, the richer you'll be when you retire.
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