First job? Retirement planning starts now
If you’ve received your first paycheck, you’re in a perfect position to start saving for retirement. Though you may be tempted to drop some of the money on new clothes or concert tickets, you’d be smart to put some aside. Saving and investing early can help you pursue your short- and long-term financial goals, including your retirement goals. Here’s some info to help you get started:
The ABCs of 401(k)s and similar employer-sponsored plans
If your employer offers a retirement plan, take a close look at its details. The many advantages of contributing to an employer-sponsored plan, such as a 401(k) or 403(b), may include:
- Pre-tax contributions: If your employer-sponsored plan allows these, you don’t pay federal and perhaps state income taxes on what you contribute—or on any qualified investment earnings—until you take a withdrawal. That reduces your taxable income now, which can be especially valuable if you’re in a higher tax bracket. When you retire, and presumably enter a lower tax bracket, you could pay less in taxes then too.
| Without 401(k) | With 401(k) | |
|---|---|---|
| Annual salary | $40,000 | $40,000 |
| Annual 6% pre-tax contribution | $0 | $2,400 ($200/mo.) |
| Net salary after contribution | $40,000 | $37,600 |
| Estimated federal income taxes | $3,170 | $2,882 |
| Tax savings | $0 | $288 |
This example is for illustrative purposes only.*
- Post-tax contributions: Some employer-sponsored retirement plans allow you to make post-tax contributions. This can be beneficial to those who are in a low tax bracket now. Although you pay taxes on your contributions, you may not have to pay taxes on the investment earnings if it’s a Roth account and certain conditions are met when you withdraw them in or near retirement.
- Tax-deferred growth: You don’t pay taxes on investment earnings until withdrawal. This gives your account added growth potential.
- Matching contributions: Your employer may offer matching contributions—meaning for every $1 you contribute, they match a percentage up to a certain dollar amount. Take advantage of this benefit by contributing enough to maximize the match. Learn more about making the most of your 401(k) plan.
- Choice of investments: Generally, in a 401(k) or similar plan, you have a choice of investments, ranging from conservative to aggressive. Many plans offer target date funds, which you might peg to your expected retirement date.1 Typically, these funds comprise a mix of stock and bond funds designed to gradually reduce your investment risk as you approach retirement.
- Vesting: The vested balance is the amount in your account that belongs to you. You always own your contributions; however, their value could go up or down, since investing comes with risk, including loss of principal, and no guarantee of returns. The employer match, if any, and any earnings on the match may vest at a scheduled rate determined by the plan.
If you leave your job, the vested balance remains yours. You may generally choose to roll it into an IRA or your new employer’s plan (if your new employer’s plan permits), take a distribution or leave the account where it is.2 Read more about these choices at Merrill Edge. Your HR representative or a financial advisor can also be a good resource to answer questions.
If you can contribute to an employer-sponsored plan, starting early can make a big difference. Consider what could happen if you start saving with your first job:
| Contributing | $200/mo. starting age 22 (until 62) | $200/mo. starting age 32 (until 62) |
|---|---|---|
| Total deductions | $96,000 | $72,000 |
| Could grow to | $297,713 | $163,740 |
This example is for illustrative purposes only and may not come to pass.**
No 401(k)? Consider an IRA
If you don’t have access to an employer-sponsored plan, perhaps because you work gigs or are a freelancer, consider whether an IRA is right for you. You may qualify for one if you have any taxable income in a given year. Contributions to a traditional IRA may be tax-deductible now, depending on your income and whether you or your spouse participate in an employer-sponsored retirement plan, but you pay taxes when you withdraw the money. In a Roth IRA, contributions are made with after-tax money, but qualified distributions are federal tax-free in retirement.
Tip: Since you’re just starting out, and may be in a lower tax bracket than in your later earning years, the potential value of the tax deduction you’d get with a traditional IRA is reduced. For that reason, a Roth IRA might be a better option if you’re in your first job.
If you start contributing to a Roth IRA when you’re young, and earn a decent return, you could end up with a tidy sum. And as long as you wait until age 59½ to start withdrawing, you don’t have to give the IRS a dime, provided certain requirements are met (although you may owe state and/or local income taxes on the money).
Annual contribution
$4,500
Length
30 years
Growth per year
5%
Savings at age 55
$313,924
This example is for illustrative purposes only and may not come to pass.**
The IRS limits who is eligible to contribute to a Roth IRA and how much you can contribute, based on your income and other factors. But remember, the sooner you invest your money—whether through an IRA or an employer-sponsored plan—the more time it has the potential to grow.
- The target date for these funds is the approximate date an investor plans to start withdrawing the assets. The principal value of these funds is not guaranteed at any time, including the target date. These funds are designed to become more conservative as the target date approaches.
- Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, and tax treatment, and provide different protection from creditors and legal judgments. These are complex choices and should be considered with care. You should consult with your tax advisor when making these decisions.
* This example is for illustrative purposes only. It assumes a 6% annual contribution (but you can contribute up to the plan’s maximum contribution limit, subject to tax law limitations) and was developed using the Internal Revenue Service’s 2018 Tax Rate Schedules. It assumes a filing status of “single,” using the standard deduction. Your taxes may differ; please see a tax advisor for more information. Taxes are due upon withdrawal from the 401(k) plan. You may also be subject to a 10% additional federal tax if you take a withdrawal from the 401(k) plan prior to age 59½.
** These hypothetical illustrations assume contributions are made at the beginning of the month and a 5% annual rate of return with no employer match for employer-sponsored plans. Results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value can fluctuate, and when redeemed, the investments may be worth more or less than the original cost. Taxes may be due upon withdrawal, dependent on account type. If you take a withdrawal prior to age 59½, you may also be subject to a 10% additional federal tax. However, for Roth IRAs, you generally may withdraw your contributions (but not your gains) at any time without taxes.
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