August 31, 2007
I lived paycheck to paycheck during my early twenties. Saving didn't seem feasible there were just too many expenses. And, like many, during my early workforce years I neglected to have a portion of my paycheck automatically put into a retirement account.
It's ironic that when you're young and struggling you can make the biggest impact on your financial future. Now, quite a few years later, my 401(k) is finally in decent shape and I'm onto the next hurdle – saving for my kids' college education.
Here are a few ideas to help get you or your children on the right track:
The power of compounding. At 22, you're twice as far from age 65 as from birth, so it's hard to think seriously about retirement. But compound earnings – where interest earned on your savings in turn generates more earning – can snowball over time. Here's an example:
Say you're 22, earn $30,000 a year and put aside 6 percent of pay ($150 a month) until age 65. At an 8 percent average annual rate of return, your $77,400 investment will grow to $619,000 by then. But if you don't begin saving until 32 and set aside the same monthly amount, you'll only accumulate $274,000 by 65 – a huge difference. By increasing the percentage of pay you save and factoring in annual raises, your savings will skyrocket even further.
Be tax smart. If you don't participate in your employer's 401(k) plan, you're missing a great savings opportunity. Money is deducted from your paycheck before being taxed, which lowers your taxable income and thus, your taxes. You aren't taxed until withdrawal at retirement, when your taxable income and tax rate may be much lower.
Many companies match a portion of your contributions as an incentive to save commonly 50 percent of your first 3 percent of pay saved, or better. That's like getting a 50 percent rate of return. Be sure to contribute enough to take full advantage of the match; otherwise, you're throwing away a sizeable gift. Practical Money Skills for Life, a free personal financial management site sponsored by Visa Inc., has a complete guide to 401(k) plans and other employer-provided benefits (www.practicalmoneyskills.com/benefits).
If a 401(k) plan isn't available, try a Roth IRA. Although initial contributions are taxed, you'll never pay taxes on the earnings, which will grow rapidly with compounding. The earlier you contribute to a Roth, the bigger your tax savings. As always, consult a financial professional regarding your personal situation.
Trouble saving? Start small. Put leftover change in a jar each night and skip a few lattes. Every few weeks, deposit the money in a high-yield, money market savings account (find the best ones at www.bankrate.com). You'll be surprised how quickly it accumulates. Whenever you get a raise or bonus, bank at least part – or better yet, increase your 401(k) contribution.
Saving is never easy, but if you establish good habits early on, you'll find the long-term rewards are too good to pass up.
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