Dear Carrie,
I'm 28 and have a good job. My company offers a 401(k) but I haven't signed up yet-- mostly because I don't understand if it's the best move, but also because retirement seems SO far away! Also, I probably don't want to stay with this company forever, so it seems like maybe an IRA is a better way to go. Can you help me decide?
--A Reader
Dear Reader,
First, congratulations. Finding a good job these days isn't always easy, so that's an achievement. And I'm impressed that you're thinking about saving for retirement. A lot has been written about your generation's focus on freedom and experience rather than possessions. I get that. And to me, there's no better way to continue having that freedom than socking money away for the future.
But back to the present.
Your company sponsored 401(k) is often your best bet for getting started
I can understand your reluctance to put money toward a time that seems so far in the future, but I strongly encourage you to start contributing to your 401(k) right away. At your age, you can end up with a pretty good nest egg by saving just 10-15 percent of your annual salary during your working years. However, if you delay saving (or take an early retirement), that percentage will need to go up, possibly in a big way.
Plus, if your company matches your contributions, you should definitely take advantage of it. Let's say it matches up to 6 percent of your salary. In this case, you'd want to contribute at least that much to get the full match. No reason to turn away free money. For the record, the 2016 401(k) annual contribution limit is $18,000.
And if you don't stay with your employer forever, don't worry. You'll likely have the option to take your 401(k) with you to your next job. Or if not, you can roll it over into an IRA when you leave.
So get the details. First, find out if your company offers a traditional or a Roth 401(k) or both. The difference between the two is when you pay income taxes. You don't pay income taxes upfront on contributions to a traditional 401(k). But, while earnings grow tax-deferred(1*), distributions--which you can start taking penalty-free at age 59½--are taxed as ordinary income. With a Roth 401(k), contributions are after-tax but withdrawals of both contributions and earnings are tax-free(2*), which can be a huge benefit down the road.
Starting in your 20s, it's likely that you're currently in a lower tax bracket than you will be later. That means the tax deduction of a traditional 401(k) now could be far less advantageous than getting tax-free distributions at retirement. If you have the choice, I'd seriously consider going with the Roth.
One more thing: ask about the vesting schedule for the company match. Some 401(k) matching contributions vest immediately, but some companies require that you stay a certain number of years to get the entire match. That's something to keep in mind if you consider changing jobs.
Expand your savings with an IRA
Another bit of good news is that it doesn't have to be an either/or situation with a 401(k) and an IRA. You can have both. Again, you have a choice between a traditional and a Roth IRA.
You can contribute the annual maximum to your IRA (currently $5,500) on top of what you contribute to your 401(k) so one potential strategy is to first contribute up to the company match in your 401(k), then put any added savings in your IRA.
Take advantage of investing technology
Saving is only part of the equation. Investing is the other. You want to invest your money in a smart, diverse and low cost way to get the most out of your savings.
With a 401(k), you'll likely have a number of preset investment choices. But with an IRA--whether you open one now or eventually leave your company and roll your 401(k) into a Rollover IRA--you're on your own. And as challenging as it can be to choose saving for retirement over spending today, successfully navigating your investment strategy on your own can be even more challenging. Fortunately, with today's technology, you don't have to do it all yourself.
Many financial services companies now offer online investment advisory services with low fees to help you build and manage a portfolio that reflects your personal goals and timeframe. You may have heard of them referred to as robo-advisors. The process usually involves answering a series of questions online that are designed to help you automatically build, monitor and rebalance your investments.
Let your circumstances guide your choices
Millennials face a different financial world than previous generations. Especially when it comes to retirement, you have more options to help you be self-reliant. So whether you stay with your current employer or set off on your own in the future, you do have choices. And starting to save early is often the best way to ensure you can continue to choose your own path.
(1*) With a tax-deferred investment, your earnings can grow tax-free until you withdraw them. This means that instead of paying taxes on returns as they grow, you pay taxes only at a later date. IRAs and deferred annuities are common tax-deferred investments.
(2*) Tax-free withdrawals of earnings are permitted five years after the first contribution that created the account. Once the five-year requirement is met, distributions, if taken, will be free from federal income taxes: (1) after age 59½; (2) on account of disability or death; or (3) to pay up to $10,000 of the expenses of purchasing a first home. Withdrawals that do not meet these qualifications will be subject to ordinary income taxes and a 10% federal tax penalty.
Looking for answers to your retirement questions? Check out Carrie's book, "The Charles Schwab Guide to Finances After Fifty: Answers to Your Most Important Money Questions."
This article originally appeared on Schwab.com. You can e-mail Carrie at askcarrie@schwab.com, or click here for additional Ask Carrie columns. This column is no substitute for an individualized recommendation, tax, legal or personalized investment advice. Asset allocation and diversification cannot ensure a profit or eliminate the risk of investment losses. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager. Diversification cannot ensure a profit or eliminate the risk of investment losses.
The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.
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