5 Retirement Plans That Won't Have Millennials Living Paycheck To Paycheck
While many of us are still in student loan debt and need to debate whether or not we should upgrade to commercial-free Hulu, saving for retirement is not on the priority list.
But, it should be.
There are enormous advantages to saving early on in life.
I encourage Millennials not to be intimidated by retirement planning and saving, even if it means short-term discomfort.
I get it; our tax code is 74,608 pages long.
Retirement plans are difficult to understand.
They use words like “qualified" or “self directed," and one easily loses interest before learning how it actually works.
The truth is, however, these plans were put in place to help you save money and to grow your money through investments.
That way, you can have money when you are old and can no longer make it.
I recently sat with a client to review his 401(k) from 25 years ago.
During his five years as an IBM salesperson, he put away $40,000 for retirement.
He looked at the account once a year.
He had not added any additional money, and he hadn't adjusted the original investment.
Twenty-five years later, his 401(k) is worth $507,031.
In a simple example of the power of retirement investing, if a 20-year-old puts away $5,500 per year and allows it grow at a modest 5 percent, they would retire with more than $1.2 million when they reach retirement age of 59.5.
The most important component of a retirement plan is that in one way or another, it strives to be tax efficient.
That does not mean you do not pay taxes.
We always pay taxes.
Tax efficiency means there is a tax-saving tool involved.
How can I open a retirement account?
- Ask a financial advisor. Financial advisors are hungry for new business, and they love working with Millennials because of their potential to grow in their careers.
- Open an account with a mutual fund company. You can do this online or on the phone.
- Talk to your HR department about your firm's 401(k) plan.
Here are the different plans and what you need to know about them:
1. 401(k)
Who
Anyone who is employed by a company that offers a 401(k) plan.
How much
An $18,000 per year maximum.
What
- Contributions are reduced from your salary automatically. You can pick what percentage of your salary you would like to contribute.
When people say “max out your 401(k)," that means you contribute as much as your company or tax laws will allow you to.
- Contributions are made pre-tax.
- Taxes are paid when you take money out (make a distribution).
Pros
- Pre-tax money allows your investment to grow from a larger amount of money than it would have otherwise had, allowing your investment to grow faster.
- Employers can make matching contributions to the plan for their employees. This means they can put money in the plan for you, if you contribute to the plan yourself.
Cons
- You have to use the investment options that the employer has picked.
When
- Money can be withdrawn without penalties at 59.5 years old and older.
- If money is withdrawn earlier than 59.5 years old, there is a 10 percent penalty (with exceptions).
- At 70.5, the plan holder is required to take out a certain dollar amount each year (required minimum distribution).
2. Traditional IRA
Who
Anyone that earns taxable income or has a spouse that earns taxable income.
How much
A $5,500 per year maximum.
What
- Contributions are made pre-tax.
- You pay the tax when you withdraw money (take a distribution).
Pros
- Pre-tax money allows your investment to grow at a faster rate.
- You can invest this money in any investments that your bank offers.
Cons
- You pay tax when you withdraw at the present tax rate. If your tax bracket is higher when you withdraw, you would be paying more in taxes.
When
- Money can be withdrawn without penalties at 59.5 years old and older.
- If money is withdrawn earlier than 59.5 years old, there is a 10 percent penalty (with exceptions).
- At 70.5, the plan holder is required to take out a certain dollar amount each year (required minimum distribution).
3. Roth IRA
Who
Single persons who earn $116,000 per year or married couples filing jointly earning less than $183,000.
How much
A $5,500 per year maximum.
What
- Contributions are made after taxes, but no taxes are paid when you withdraw. (It’s a nice gift to yourself when you are old.)
Pros
- Even if you are in a higher tax bracket from when you contributed, you do not need to pay taxes after the initial contribution.
- There is no required minimum distribution when you are 70.5.
Cons
- When you pay taxes up front, the investment will have less money to grow from.
When
- Money can be withdrawn without penalties at 59.5 years old and older.
- If money is withdrawn earlier than 59.5 years old, there is a 10 percent penalty (with exceptions).
4. SEP IRA
Who
Business owners or employees of small businesses.
How much
The lesser of 25 percent of an employee's compensation or $51,000.
What
- A retirement plan that an employer can establish for him- or herself and the employees.
- The employer is allowed a tax deduction for contributions made to the SEP plan.
Pros
- As an employee, it’s free money from your employer.
- As an employer, the contribution is a tax deduction.
Cons
- Taxes are paid when you withdraw at the present tax rate.
When
- Money can be withdrawn without penalties at 59.5 years old and older.
- If money is withdrawn earlier than 59.5 years old, there is a 10 percent penalty (with exceptions).
- At 70.5, the plan holder is required to take out a certain dollar amount each year (required minimum distribution).
5. SIMPLE IRA
Who
Business owners or employees of businesses with 100 employees or fewer.
How much
A $12,500 maximum contribution.
What
- Contributions are reduced from the employee’s salary.
- Employers can contribute to their accounts or to their employees' accounts.
- Contributions are made pre-tax.
- Taxes are paid when you take money out (make a distribution).
Pros
- Pre-tax money allows your investment to grow at a faster rate.
- Employee can decide how much to contribute.
Cons
- If under 59.5 and withdrawn within the first two years of participation, there could be up to a 25 percent penalty.
- If money is withdrawn earlier than 59.5 years old, but after the first two years, there is a 10 percent penalty (with exceptions).
Whether you are rich or poor, do yourself the favor of getting educated on retirement planning and investing.
Consult your tax advisor, reach out to a financial advisor or open a plan online.
Your future self will thank you.
