Saving for retirement can seem scary to current college students or recent graduates, but investing for retirement while young is one of the best things you can do to ensure you’ll have enough money for retirement.
People often think they have to spent the majority of their paycheck to see any kind of return on their investments. This isn’t true, especially if you begin investing as early as you can! College students and recent grads should take advantage of a Roth 401k or IRA plan, because it’s a fantastical way to get large returns on small investments. Learn more about why to get one while still in college or as a recent graduate.
What’s a 401k plan?
Let’s start with the basics. A 401k is a retirement plan that’s employer-sponsored. Usually, employers will match your contributions to a 401k plan up to a certain amount, which is quite literally free money you can put towards your retirement investments. You choose the amount you’d like to contribute to the plan, and the money is taken directly out of your paycheck.
Once you’ve placed money in your 401k, it will be invested in different areas of the financial market. However, your employer will be investing on your behalf, meaning that you usually have less control over where your money is being invested than you would with an IRA plan.
The amount you can contribute to a 401k can differ by your employer or your total salary. In 2017, anyone can invest up to ,000 per year, and if you are 50 years or older, you can invest an additional ,000.
What’s an IRA plan?
IRA stands for individual retirement account. It is an account is set up directly between you and an investment firm. Because your employer isn’t involved in this retirement plan, they will not match your contributions. However, this also means that you have more freedom to decide exactly how much you’d like to invest in your account and where you’d like to invest your money.
The contribution limits for both a traditional and Roth IRAs are the same: ,500 per year, or ,500 if you’re age 50 or older.
Why is a Roth 401k or IRA plan better than a traditional 401k or IRA plan?
When considering a Roth 401k compared to a traditional 401k or IRA plan, it is important to consider taxes. When you invest money, you have two options: you can invest with pre- or post-tax money. If you invest with pre-tax money, you don’t pay taxes on the money you earn now, but you will have to pay taxes on your money and all your interest earnings when you withdraw the money during retirement. This type of investment is known as a traditional 401k or IRA account.
If you invest with post-taxed money, any interest you earn on your investments will be tax-free. This type of investment is done through a Roth 401k or IRA account.
If you'll be in the same income tax bracket now and in retirement, there isn’t a difference between the after-tax amount you’ll get to spend in your retirement between a traditional and Roth 401k or IRA plan. However, most college students and recent graduates aren’t making a lot of money, meaning that they are in significantly lower income tax brackets than they will be during retirement.
By choosing to invest with post-tax dollars in a Roth 401k or IRA plan, you can tax your money at a low tax rate and keep all the interest you’ll earn over time. This is basically free money for younger investors, who can benefit from decades of tax-free compounded growth.
Why should I save for retirement now?
One-third of Americans report they have no retirement savings, yet almost every working person looks forward to the day they can retire! Don’t fall victim to the idea that you should push off retirement savings because you’re in debt or have a smaller paycheck than you’d like.
If you want financial freedom when you’re older, there is no better time to invest than now. If you make saving for retirement a priority now, you will reap the rewards of decades of tax-free interest and be able to retire comfortably.
Author: Lauren Freeman loves to chat about finance and all things related to money. She currently works for Real PDL Help, a company focused on helping people get out of payday loan debt and take control of their finances.