New to the Workforce? Contribute to Your Retirement

If you are a recent college graduate that has just entered the workforce, you have an excellent chance for a comfortable retirement if you begin contributing to your retirement as soon as possible. If you are 24 years of age or younger, you have at least 35 years until you reach age 59 1/2 (minimum age to begin withdrawing from a retirement account without penalty). That’s at least 35 years to let the magic of compound interest work for you. What exactly does that mean? Let’s look at some numbers as an example with a few basic assumptions:

• There are 35 years between now and your retirement
• Your retirement investments average a 10% annual return (fairly reasonable long-term return estimate)
• Inflation over the next 35 years is 4%
• You invest $50 a paycheck and you are paid biweekly (26 paychecks a year)

By investing just $50 every two weeks at a 10% annual return, in 35 years you will have $414,620.36! However, accounting for inflation, it would only be worth $154,839.47 in today’s dollars. That’s not bad pile of cash, but it won’t be enough to get you through retirement. That means you’re going to need more than just $50 a paycheck. If your employer has a 401k plan in which they provide matching contributions, it can help be a source of the extra money you will need.

A 401k is an employer-sponsored plan, where employees can make pre-tax contributions into a retirement account. The contributions made in the account grow tax-deferred, meaning they are not taxed until withdrawn during retirement. More often than not, as an added benefit employers will contribute matching funds for employee contributions. For example, my employer will match 100% of the first 3% of salary contributed, and 50% of the next 2% of my salary. Confused? Basically, it means if I contribute 5% of my salary my employer will match with 4% of my salary.

Let’s continue the example with the 4% match on 5% of salary. To keep things simple, let’s say that $50 biweekly is 5% of your salary and is your contribution in your 401k. That means for every $50 you put in, your employer will contribute $40 more. With $90 in biweekly contributions, in 35 years you will have $746,316.65 or $278,711.04 in today’s dollars. Of course, if you as me, you should try to contribute more than just 5% of your salary.

So what’s the catch with the employer matching? In order to become fully vested (be allowed to keep the match), you have to remain an employee with the company for a specified amount of time. Your employer may allow you to keep all or nothing after a certain period of tenure (cliff-vesting schedule) or they may allow you to keep certain percentages after reaching certain tenure milestones (graded-vesting schedule). Regardless of your tenure, if you leave the company all of your contributions will remain yours.

If your employer doesn’t have a 401k plan, there are other types of retirement accounts you can open on your own behalf. One of the best is a Roth IRA (Individual Retirement Account). With a Roth IRA, you make after-tax contributions into a retirement account that grows tax-free. That means when you withdraw during retirement, you won’t pay taxes on it. There are some income limitations, so if your income is too high (six-figure range) you won’t be able to contribute to a Roth IRA, but you can still contribute to a traditional IRA. With a traditional IRA, your contributions grow tax-deferred. That means you will have to pay taxes when you begin making withdrawals during retirement. So you can see, the Roth IRA is more advantageous if you qualify for it. There are annual contribution limits for both types of accounts.

When you first begin contributing to a retirement account, if you are young and a long way away from retirement, you should put your money into aggressive growth investments. The value of the account may move up and down considerably with aggressive investments, but in the long run it should increase. As you near retirement, investments should become less aggressive in order to preserve the earnings made over the years. That means that it may be possible you may not even reach the $278,711.04 in today’s dollars mentioned in the example. However, there is some good news that will help you accumulate more wealth for retirement. As you continue working, your salary should increase as you receive merit increases, cost of living increases, and advance into positions with a higher salary. This means that your contributions will not remain constant, but should gradually increase year-after-year.

How much money you will need for retirement depends on your life expectancy, how much you will need to withdraw each year, and what kind of return you are receiving while you are withdrawing. Maybe $1,000,000 sounds like a good number. Let’s see… Here are the assumptions:

• You have accumulated $1,000,000 for retirement
• You withdraw $70,000 per year
• During your retirement, your $1,000,000 is earning 3% interest
• During your retirement, inflation is growing at 4%, giving you effectively -1% interest

$1,000,000 would last you about 14 years. If you start withdrawing at age 59 1/2, that means it would last you until age 73. Hmm, that’s probably not long enough. But wait, it gets worse! Although we did account for inflation during the retirement period, we forgot to adjust the $70,000 annual withdrawal for inflation. The equivalent of $70,000 in todays dollars will be nearly $300,000 in 35 years (with 4% inflation)! If you want to withdraw $300,000, your nest egg is only going to last you about three years. Yikes!

If you need $300,000 year for 30 years in retirement, that means you will need to accumulate over $10 million! Although that may seem like an impossible task, it can be accomplished. The earlier you start, the better your chances of achieving a comfortable retirement. It gives you more time for compound interest and your increasing salary to work for you. The more you contribute each paycheck, the better your chances are as well. So what are you waiting for?!?

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