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Written by: Ken Shapiro | Condor Capital Management
For millennials, also referred to as Gen Y, retirement can seem light-years away. While retirement might feel like a lifetime away, the actions that people take in their 20s and 30s will often define what that retirement future looks like.
Start Saving Early and Often
As you invest, your portfolio has the ability to generate earnings in the form of capital gains, interest, and dividends. As these earnings are reinvested, they can begin to generate earnings themselves. This process is called compounding. The earlier a person starts saving, the longer compounding has to grow the portfolio. It is a snowball effect that can significantly increase a person’s wealth over long periods of time. Therefore, the earlier you can start saving, even a small amount, the better off you will be.
Be Mindful of the Little Things
Initially, it is not uncommon for young people to struggle with saving. For some, it is a cash flow problem. Graduating college with high student loan payments can squeeze the budget for young adults when they are establishing themselves. For others, it is a matter of prioritization. A good way to create surplus savings in a tight budget is to cut back on small luxuries. Small frequent expenses, like ATM fees, can add up over time. For example, saving $5 a day Monday through Friday on a latte before work will save you around $108 a month, or $1,300 a year. Once you create a surplus in your cash flow, the next step is to actually save it.
The Roth Advantage
Another great place to save money for retirement is the Roth IRA. The main difference between the Roth IRA and the traditional IRA is the tax treatment of the dollars. As long as they meet the requirements, investors are able to deduct the contributions they make to a traditional IRA from their income taxes. Money contributed to a Roth is contributed after tax, so there is no tax deduction for contributions. However, the tradeoff for paying the taxes today is that qualified distributions can be withdrawn tax-free later in retirement. Roth IRA contributions are phased out at higher income levels ($118,000 for single filers and $186,000 for married joint filers), but since millennials entering the workforce are typically starting at lower salaries, they should fall below the limits. For a worker in a low tax bracket today, the Roth could be the better option if they expect to be in a higher tax bracket during retirement. As careers progress, salaries typically will go up, slowly moving people into higher tax-brackets. At that point the traditional IRA could be the better option if you anticipate that your tax rate in retirement will be lower. Another strategy is to diversify the tax treatment of your portfolio, by making tax-deductible contributions to a 401k, in addition to Roth IRA contributions, if both accounts are available and you are eligible.
Take Advantage of Your Employer Match
Don’t leave money on the table. If your employer’s 401k plan offers matching contributions, it rarely ever makes sense not to take advantage of the benefit. Some companies offer a contribution match to your retirement savings based off of your personal contributions. For example, if you contribute 5% of your salary to your 401k plan, XYZ Company may match 4% into your account. These contributions may have a vesting schedule. This varies among employers, but a common vesting schedule gradually vests over time, like 20% a year for 5 years. Traditional 401k plans historically were the most common type of 401k, but Roth 401ks have been growing in popularity in recent years. Unfortunately, even if you select a Roth 401k, the employer contributions are made pretax and will still be taxable when distributed.
In conclusion, it is important for millennials to start saving as often and early as they can. Controlling small luxuries and saving the proceeds in a tax-advantaged account, like the Roth IRA, is a good start towards one’s retirement future.