Starting Out
The Quarter-Life Retirement Plan
You just started working, but it's never too early to dream about when you can quit -- for good. Here's your guide to making it happen.
By Erin Burt, Contributing Editor, Kiplinger.com
July 3, 2008
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I often dream about quitting my job.
Don't get me wrong. I love what I do, and I haven't been doing it that long -- I'm still in my twenties, after all. I know I have many years of work ahead of me. But I don't want to work forever, so I've already set a plan in motion to make my escape.
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You should be dreaming, too. Retirement may be decades away, but all of us, no matter our job or how many rich relatives we have, can secure a comfortable future. The trick is to start now, in our twenties, while time is on our side.
No pain, much gain
Even if you're not sure yet how you want to spend your retirement, start raising the money now. Doing so gives yourself the freedom to dream as big as you want, so your lack of funds can't hold you back.
Plus, the earlier you get going, the fewer sacrifices you'll have to make to save the money. I've said it before, and I'll say it again (and again, and again): Small contributions saved over a long time add up to big bucks! It's not hard if you begin young.
Say, for example, a 22-year-old gets his first job out of college and starts saving $200 per month. If he earns an average 10% annual return on his money, by age 65 he'd have $1.5 million, and it took minimal -- if any -- financial sacrifice. If he added a mere $67 per month on top of that, he'd be sitting on a cool $2 million in retirement.
Consider now that he didn't start staving until age 35. He'd have to scrape up $721 per month for the next 30 years to get $1.5 million, and $962 per month for $2 million. That may be doable, but it will probably require big cutbacks elsewhere in his life, especially if he's starting to save cold turkey.
Make saving a habit while you're young and you won't miss the money when it's gone. (Think you don't have enough money to start saving? See Save Money on Practically Everything for dozens of ways to free up cash in your budget.)
401(k) vs. IRA
Your first stop for retirement savings is your workplace 401(k) if your employer offers a match on your contributions, such as 50-cents for every dollar. That's free money, baby, and you shouldn't pass it up.
The 401(k) is named for a section of the tax code, but underneath its nerdy exterior, it's one smooth operator that'll help make your retirement dreams come true. (The 401(k) is also known as a 403(b) or 457 plan, depending on where you work.)
Basically, with a 401(k), your employer presents you with a list of pre-selected mutual funds. You choose which ones you want to invest in and tell your employer how much money you'd like to contribute each pay period. Then, those contributions are automatically taken out of your paycheck before taxes. (You get a tax break now, but you'll pay taxes on the money when you withdraw in retirement.) And if your employer offers a match on your money, it also is kicked in.
More employers are offering a choice between a traditional 401(k) and a Roth 401(k). In this case, go for the Roth. Your contributions with a Roth are taken out after taxes, so you won't get the tax break now. But withdrawals from a Roth 401(k) are tax-free in retirement -- when you will almost certainly be in a higher bracket. Translation: The Roth 401(k) is the better deal for most young adults.
If your employer doesn't match 401(k) contributions or offer a Roth 401(k), you would be better off maxing out a Roth IRA outside the workplace first, and then saving in your 401(k). As with a Roth 401(k), withdrawals from a Roth IRA are tax-free in retirement. (See Why You Need a Roth IRA to learn more.)
How much, and where?
How much, exactly, should you save? The IRS won't allow you to set aside more than $15,500 in your 401(k) and $5,000 in your Roth IRA for 2008. Within those limits, the amount you save is up to you.
Check your budget to figure out how much you can realistically save each month. Make sure you have room to set aside some money in a savings account for an emergency fund. Once your needs -- and a few wants -- are taken care of, it makes good sense to save as much as you can in your tax-sheltered retirement accounts.
With a 401(k) and Roth IRA, you are in charge of choosing your investments, so pick wisely. Most employer plans offer a variety of mutual funds, which are also great investments for your Roth IRA (see A Beginning Investor's Best Friend).
At this point, the majority of your portfolio should be in stock funds, which offer the most potential for growth. Start out with a diversified stock fund -- one that invests in a broad range of stock types -- so you're not putting all your eggs in one basket. So, for example, a mutual fund that mirrors the performance of the overall stock market is a good place to start (such as Fidelity Spartan Total Market Index). A fund of funds can provide good diversification (such as T. Rowe Price Spectrum Growth). And so-called target funds are also fine choices (T. Rowe Price, Fidelity and Vanguard each offer good selections).
Note of caution: Don't overload on your company's stock in your 401(k). If your employer goes under, you'd not only lose your job but also a good chunk of your retirement savings.
As your account balance grows, you can branch out your investments if you desire. (Check out Kiplinger's list of the 25 best mutual funds for portfolio ideas.)
It's important to periodically evaluate your savings plan -- say, once a year -- to make sure it's working well with your budget and your goals. Use our new retirement calculator to see if you are saving enough to get where you want to be down the road.
Reader Comments (27)
Posted by: Tom at 07/03/2008 08:21:47 AM
Enjoyable article Erin. I agree that time and a cadence of savings has a great impact on a person's ability to retire. The one small nit I have is when compounded numbers are discussed (e.g. $1.5MM at 65) rarely do I see what that figure is in today's dollar (assuming inflation). While I agree any savings is good savings, one needs to accelerate their savings as their salary grows. Personally, I have shared with my family that saving $2000/year (roughly 200/month) will not get you close to where you would want to be at age 65.
Posted by: MrReality at 07/03/2008 10:02:47 AM
This is all excellent advice. I do wish, however, that articles like this would NOT use 10% return on investment in the example scenarios. This is fantasy land. True, over the last 100 years, this is the "historical" ROI and bla, bla, bla. That's ancient history. This was before the age of excessive (obscene actually) executive compensation packages. There is no way we will ever see returns of 8%, 10% etc as long is cash is exiting companies at such astronomical rates. Any potential return to shareholders is being gobbled up by huge pay packages, perks, and golden parachutes. The final insult here is that the cash is going to executives for awful (or at best mediocre) performance. Say goodbye to yesterdays returns. We live in new world now.
Posted by: Chris P at 07/03/2008 03:41:44 PM
As a third tax-advantaged option, why not use a Health Savings Account? Many quarter-lifers like myself can tolerate high-deductible med plans, and HSAs are like mini-401(k)s with potential above-the-line AND growth-deferral AND free-withdrawal tax breaks. At a $3,000 contribution max for singles in 2009, HSAs will be where IRA limits were just 5 years ago. As health care costs shift to individuals, HSAs will only increase in contribution maxes and popularity. Their requirements encourage maintaining good independent health too. Together with $15,500 to 401(k)s, $5000 to IRAs, and $2900 to HSAs, many young low-bracket employees should tax-shelter about $24,000/year before even considering any other vehicle for retirement.
Posted by: alejandro at 07/03/2008 10:04:23 PM
interesting..however if my goal were to accumulate said mulah by said age, i'd say life at said time would be pretty bland wouldn't ya think? 10% is a wonderful goal as well. unfortunately 99% of the people living in said country do not think about the future. sad but true. what they need is a little risk management in their lives, unfortunately now our economy is in said toilet and people, people are getting poor...
Posted by: Nomen at 07/03/2008 10:27:21 PM
Saving earlier in a matching 401K is good advice. But if inflation where to average 4% for the next 30 years that $1.5 million would only equal about $450,000 in today's dollars which may be barely enough. The biggest mistake I see most young people make is to start out with a large student loan, a house 30 year loan and a series of 6 year loans against two automobiles for most of their life. Easily half or more of a their lifetime income will end up going to pay interest. I advise my children to keep their loans to a minimum and pay them off as early as possible. Consider a double monthly payment as a type of reverse savings account that saves you interest. After 10-15 years the house will be paid off and then use the money previously used to make house payments to buy IRAs,savings bonds,CDs,and dividend paying stocks. Add this to the 401K when they started working and they will have invested safely and accumulated some serious money for their retirement by age 55 if not sooner. My youngest is on track to retire by age 45 if he wants to.
Posted by: Mark N at 07/04/2008 10:40:10 AM
To Mr. Reality, I see you challenged the article's assumed 10% annual growth as being unrealistic. I have charted my 401k contribution's year on year for about 25 years and can confirm 10% is a conservative average. Unless you have opted to choose no risk low yielding bond funds (which sounds like your case)I see no reason why you can't plan and achieve an average of 10% over a 30 year period. My average adjusted for the current down swing is 14% year on year for 25 years, I suspect that if you properly chart your performance that it is very likely more than it appears.
Posted by: kville at 07/07/2008 01:06:25 PM
I agree with Nomen's advice--keep debt to a minimum and pay it off as soon as you can. I racked up over $52,000 in consumer debt in the years between my late twenties and early thirties, and I have spent all that time and more paying it down. If I hadn't been such an idiot, by now I would have been able to amass a nice downpayment on a house, and have a fat emergency cushion as well. I have about $20,000 to go before I'm debt-free, and while I'm relieved that I can see the light at the end of the tunnel, I can tell you that the psychological weight of debt is crushing--you don't need that on top of job stress, especially when you're just starting out in a career.
Posted by: andrew at 07/08/2008 07:32:22 PM
Chris P- Yes, I recently switched to an HSA, where my employer contributes $1500 a year. Another great way to maximize your tax breaks.
Posted by: Tom at 07/09/2008 06:30:43 PM
So what do you do if: 1 - You are married, filing jointly and make more than the Roth IRA limits ($160k+) 2 - Your work does not have a 401k What is the best option then? Thanks!
Posted by: Erin Burt at 07/10/2008 01:00:04 PM
Tom: Hi, this is Erin Burt, author of this article. If you're locked out of the IRA and you don't have a 401(k) (or you've maxed it out), you have a couple of options. You might consider investing in a deferred variable annuity which will shelter your earnings until you withdraw your money after 59 1/2, when it will be taxed as ordinary income. Or take advantage of record low capital-gains rates and invest in a taxable account, focusing on growth stocks for the long haul. Kiplinger's has a good article with more ideas of how to earn more money and pay less taxes. Type "Make More Keep More" into the search box on Kiplinger.com to check it out.
Posted by: Craig at 07/10/2008 01:33:09 PM
Tom, as to your question: If neither you nor your wife are eligible to contribute to an employer-sponsored retirement plan you can both open a DEDUCTIBLE IRA (there no income limits if your employer doesn't offer a retirement plan). Yes, you will get sacked with taxes in retirement, and you will want to evaluate other options (buy and hold, with favorable long-term cap gains treatment). Other than that, the only other tax-advantaged plans you have available are annuities, which I would strongly advise against. Some of the basic things you can do to minimize taxes are: buy and hold (ETFs and tax-managed funds work well for this), pay off debt (incl mortgage), or become a landlord and aggressively pay off the rental debt. If you or your spouse start a small business on the side, you can shelter a bunch of business income using Simple IRAs, SEPs, and solo 401ks - This would then invalidate the deductible traditional IRA but, you can contribute nearly $50,000. You'd probably want to opt for the solo 401k because you're allowed to contribute 100% of your self-employment income (whereas the others are only 20%). Hope that helps.
Posted by: Chris at 07/10/2008 07:58:44 PM
Question~ I have a Roth IRA in my name (max it out), my wife has a mixed 401(k), meaning her work matches 3% into a regular 401(K) but not her roth 401(K) which she also puts money into. Is she still eligible for a Roth IRA also? We are under the 160K limit for married filing jointly.
Posted by: Melissa Moncrief at 07/14/2008 01:01:26 PM
Question: I am 22 years, I have the ability of setting aside about $300 per month for savings. I have zero savings to date and I'm hung up on how much to set aside for my "emergency" fund and how much to save for my retirement. Do you have any suggestions as to how I should split my savings contributions?
Posted by: Erin Burt at 07/15/2008 02:41:14 PM
Hi, I'm the author of this story. To Chris: Yes, your wife can contribute to both a Roth IRA and a Roth 401k.
Posted by: Erin Burt at 07/15/2008 02:51:00 PM
To Melissa: I usually recommend that you build up an emergency cash reserve of $1,000 before you start investing. So for the first few months, put all your $300 into a high-yield online savings account, such as ING Direct or HSBC Direct. Once you've got that nice $1,000 cushion, divvy up your money. Start investing some of it in a Roth IRA, and keep putting some of it into your emergency savings, too. The ratio is up to you and what you feel you'll need to reach your goals.
Posted by: Rebecca at 07/15/2008 06:01:48 PM
Question: I'm 24 years old and I'm looking to start my Roth IRA. I just don't know what company would be the best for me and what kind of significant differences there are between companies. Also once I start my Roth IRA do I have to keep it with the same company until I retire? Do you have any suggestions? Thanks
Posted by: Spencer at 07/19/2008 10:01:56 PM
I'm 15 years old and have my first job. I just got my first check last week. I want to open a Roth IRA. Do I have to wait until I pay taxes for this year, or can I put in up to what I have earned so far now? Also, which would be a good discount broker that has low fees so I could invest in stocks? I watch Suze Orman with my mom every week but I still am confused.
Posted by: Erin Burt at 07/21/2008 08:28:42 AM
For Rebecca and Spencer: Hi, Erin Burt here, author of this column. I recommend that young people invest their Roth IRAs in mutual funds, not individual stocks. A single fund allows you to diversify your money among a lot of stocks with a little money. But where? Kiplinger's did a story on the best mutual fund families. Search for "Brands You Can Trust" on Kiplinger.com. You can move your money around to different companies if you want. And you don't have to wait for tax season to open your Roth IRA. You can do it as soon as you get that first paycheck. (FYI: A good place to start is a fund company that doesn't require a huge minimum investment. T. Rowe Price, for example, lets you get started for as little as $50 a month. Search for "30-Minute Investing Start-Up Kit" on Kiplinger.com to help you get going.)
Posted by: John Paul at 08/12/2008 08:46:50 PM
I'm 22 and just started my first job. I have bonds, and some savings my parents have built for me. Also I have a current account with Edward Jones that I have been giving $60 a month to since I was a Junior in College. I want to put aside $300 a month and earn about 10% to 15% annual return. What is the best way for me to save and what questions should I ask my Edward Jones advisor? I hope you have some suggestions because I am confused. Thanks for your time.
Posted by: brad at 08/13/2008 12:48:57 PM
I've been pretty blessed and want to make the most of it. Im 24, secure employment, and have an uninvested nest egg of 10,000. After that i can save/invest 1,000 a month. i put 4% of my salary on top of my companies 6% in a 401k. i resolve to remain debt free minus my current mortage. i feel like a can be somewhat aggresive with the 10,000 (put some in PM or MNLU?) and diversify with the monthly investment. Any advise would be great, such as what % in stocks, % in index funds, et cet et cet. At this point i have no direction, thanks for the help.
Posted by: viajera80 at 08/18/2008 11:21:48 AM
Timely article. But a lot is missing from it. I am 34 and have been saving about 50 percent of my income for about 8 years now. I have a fairly high net worth (top 10 percent of my age group) and it not only takes security and additions to a 401k, but dedication and knowing EXACTLY where all your money is going. Make sure you write down every expense and find out how you spend you money, that is more key than throwing a random amount into a retirement account.
Posted by: Sue at 08/18/2008 01:13:46 PM
Tell me how a 47+ person can get back on their feet. I had stock options (with companies that dumped) and had to cash in Cash Value of Life Insurance and 401K plan after losing a job and unable to find one for over 2+ years. I am in a much better place now. But, how do you start at this age on a very small income. Just surviving?
Posted by: Jc at 08/18/2008 02:20:56 PM
Does anyone know if there is a such thing as a Roth 403(b) and/or Roth 457(b)?
Posted by: Mike at 08/19/2008 08:55:21 AM
This article, and the like, that uses a nice, round number of 10% for annual earnings is ridiculous. It's not like they are doing the calculations by hand and use an easy number to multiply things by...jeez, start plugging in real rates of return, like 3-5%. Who's earning 10% right now??
Posted by: Lorenzo at 08/19/2008 04:23:06 PM
I love all the assumptions in these calculations about annual rates of return and steady paychecks for 35 or however-many years. I'm 45, and I dutifully joined my company's 401k when I began my working career fresh out of college at age 22. I worked five years at that mind-numbing professional job, then took three years off to go to law school. Took out some student loans and worked part time. Started out at a decent salary, but then eight years later had another setback--a relocation for my spouse's job (making me the "trailing spouse") and then a divorce. I had trouble finding employment in my area of law at that point in my career due to the path I had taken. I struck out on my own. I believe my salary reached its career zenith about eight years ago. Due to corporate clients reining in costs, it's possible I will earn LESS each year....the assumption that one's salary will remain steady, let alone increase, each year, and that one will not suffer any major financial setbacks--the kind of assumptions that financial planners love to make--seems ludicrous. Life takes you where it takes you, and your money comes along for the ride.
Posted by: optimistic at 09/29/2008 05:27:24 PM
very valuable insight...Keep up the good work.
Posted by: Jimbo at 01/15/2009 04:27:49 PM
I agree with some posters that life doesn't fall into the "everything works out category" and it's so easy to retire in 25/30 years. However, the article also points out that making small but consistent contributions to retirement beginning at a young age will lead up to big big savings. And that is a goal anyone, regardless of where life takes you over the years.