Capture the match. If your employer offers a matching contribution to your 401(k), make sure to contribute enough to max out that contribution. Young, lower-paid workers are most likely to contribute below matching contribution rates – one recent study found that 40 percent of workers in their twenties contribute below the matching rate, versus only 20 percent of those in their 50s.
Don’t cash out. Many people cash out their 401(k)s when they change jobs, rather than roll savings over to the savings plan of their new employer, or to an IRA. That interrupts the flow of compound returns and it’s very difficult to make up lost ground over time. Another option is to leave the funds where they are if it’s a good plan. Also, distributions that you take before you reach the age of 59 1/2 are subject to income tax — plus a 10 percent tax penalty for early withdrawal.
Watch your fees. Fees are one of the most important determinants of long-term portfolio performance, so it’s important to know what you’re paying. If you work for a large company, odds are that the costs are reasonable. The best plans tend to be the large ones offered by major corporations. In 2013, plans with more than $1 billion had total participant-weighted costs of 0.29 percent of assets, compared with 1.17 percent for plans smaller than $10 million.
Consider a Roth. Roth IRAs really are a no-brainer for young people. With a traditional IRA, you pay taxes at the end of the line, when you withdraw the money. With a Roth, you pay the taxes upfront – but the account is tax-free forever. That’s an especially useful feature for young retirement investors, for a couple reasons. First, most people move into higher income tax brackets are they get older and make more money. So, getting the taxes out of the way at lower rates makes sense. Additionally, not only do your original contributed amounts come out tax-free – so do your investment gains.
Don’t worry about Social Security. You’ve heard politicians argue that Social Security is “bankrupt” and that it won’t be there for today’s young people. Nothing could be further from the truth.
Social Security does face a financial problem, but one that is manageable in proportion. In 2034, the Social Security Trust Fund – basically, the program’s savings account – will run dry due to accelerating retirements by the large baby boomer generation. At that point the program would have enough revenue from current tax payments to meet about 75 percent of its obligations.
That problem can be resolved through injection of additional revenue, benefit cuts or a combination of both. The right approach, I think, is to lift the cap on income subject to the payroll tax, and to raise the tax rates in very small increments over a period of years.
But if you doubt that Congress will find a solution, ask yourself this question: can you imagine any legislator who would want to return home to answer voter questions about why she just voted to cut grandma’s Social Security benefit by 25 percent.
Learn more about how Social Security works by downloading the Social Security Guide for Young People, which is published by the National Academy of Social Insurance and the Economic Policy Institute [PDF file].
Pages: 1 2