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Your 20s are a crossroads. You’re still young enough to feel invincible, but you’re on the doorstep of full-blown adulthood and real responsibility. Right now, your biggest asset isn’t your college degree or your boundless energy. Your most valuable asset is time.
You’re still decades away from retirement, so even small contributions can grow into a large nest egg thanks to compounding interest.
Why Start Saving Today?
Let’s assume you get your first full-time adult job when you’re 22. By putting just $200 a month into a retirement account that returns 8% a year, you’ll have $37,000 dollars socked away within 10 years. Ten years later, you’ll have $122,000. B the time you’re finally ready to retire at 67, you’ll be looking at a retirement account balance of more than $1.2 million.
Time can be your biggest alley or your greatest foe when it comes to retirement savings. If you start making small and consistent contributions now, you’ll be able to retire reasonably well off at 67. However, it you wait to start planning until later in life, your contributions will have to be bigger and you’ll miss a decade or more of compounding interest. Below are a couple of ways to get a head start on your retirement.
Take The 401(k)
Most large companies that offer employees a 401(k) plan match your contribution up to a certain percent. Matching contributions vary from company to company, but employer matches typically range from 25% to 100% of your contribution, up to 6% of your annual salary. Even if your employer only matches a small percentage, that’s still an immediate return on your investment, and a return that will continue compounding in the years to come.
Another benefit of 401(k) contributions is that they aren’t included in your taxable income.
No 401(k)? Fund A Roth IRA
If you work for a smaller company, there’s a good chance your employer won’t offer a 401(k). If that’s the case, you’ll have to manage your own retirement fund.
A Roth IRA is the best choice for most young workers. Your contributions won’t be tax deductible like they would be with a 401(k), but you can withdraw them at any time without a tax penalty. Even if you do have a 401(k), funding a Roth IRA is a good idea.
For 2014, you can contribute up to $5,500 in a Roth IRA. That doesn’t mean you have to contribute that much, but the more you can contribute now, the better off you’ll be in retirement.
Pay Off Student Loans — According To Your Repayment Terms
Many people want to pay off their student loans as quickly as possible, but that may not be your best bet. Federal student loan rates are generally locked in at rates below the rate of return you can expect from your retirement accounts. Instead of paying off your student loans early, invest that money into your retirement accounts and pay student loans off according to the repayment terms of your loan. You’ll be better off in the end. In addition, you get a tax deduction of up to $2,500 a year on student loan interest.
However, if you have private student loans, it’s prudent to pay those off as quickly as possible. Private student loans often carry interest rates of 8% or more. That’s getting dangerously close to what you can expect as a return rate on a typical retirement investment. Pay off private loans as quickly as possible.
Don’ Cash Out That 401(k) Early
The days of staying at a single job your entire career are over for most people. You have a number of options for your 401(k) when leaving a job. You can leave it with your former employer, roll it over into an IRA, roll it into your new employer’s retirement plan or have your old employer cash you out.
It’s tempting to take the money and run, but most of the time it’s not a good decision. Your old company automatically withholds 20% of your balance to cover taxes. Since you aren’t 55 yet, you’ll also have to pay a 10% early-withdrawal fee on the entire balance of your 401(k). Additionally, you’re losing the power of compounding interest in the coming years. It’s usually best to take your 401(k) and roll it into another retirement plan.