You know that you “should be” saving for retirement, and you’re ready to get started. So… how do you actually, you know, do it?
When you’re in your 20’s there are a couple of particularly great ways to save for retirement, and opening a retirement account is surprisingly easy.
For almost every young person, a Roth IRA is your best retirement saving option.
Quick review: a Roth IRA is a type of retirement account. You can contribute up to $5,500 of post-tax income every year. Your withdrawals in retirement won’t be taxed at all, because you already paid taxes on this money—a great deal for most young people.
This is because when you’re young, your tax bracket is usually lower than it will be when you retire. Here’s a handy chart to figure out your federal tax bracket.
If your income today is $36,000, your tax bracket is 15%. If your retirement income (which can include sources like withdrawals from retirement accounts, social security, pension money, etc) puts you in a higher tax bracket (say, 28%), you could be stuck paying an extra 13% in federal taxes on the same money. If you save for retirement through a Roth IRA, you’ll completely avoid paying that extra 13%.
How do I open a Roth IRA?
Don’t have a Roth IRA? You can easily set one up online at Fidelity or Vanguard. All you need is about ten minutes and your social security number, and both of these websites walk you through each step. Since you don’t need to contribute any money in order to open your account, this is something you can do right now!
How can I make contributions to my Roth IRA?
There are a few options, including:
- Ask your employer to automatically deposit a portion of your paycheck into your account—your HR department should be able to help with this.
- Set up regular automatic withdrawals from your checking account using your account’s routing number. This isn’t as difficult as it sounds! Here’s how to find your Fidelity account’s routing number.
- Write yourself checks to be deposited into your Roth IRA.
How much should I contribute to my Roth IRA?
Retirement may seem very far in the future, but saving for retirement is one of the best ways to build your wealth as a young person. Starting early makes an enormous difference—the impact of compound interest is pretty mind-blowing. Maxing out your Roth IRA ($5,500 per year) deserves a top spot on your list of financial goals.
If you want to max out your Roth IRA, you’ll need to contribute about $458 per month:
$5,500 / 12 months = $458.33 (post-tax contribution)
If you’re not yet in a position to save quite that much, decide your yearly goal, then divide that number by 12 (or by however many paychecks you receive annually). If your goal is $2,000 this year, expect to contribute about $88 out of your twice-monthly paycheck:
$2,000 / 24 paychecks = $88.33 (post-tax contribution)
You can contribute irregularly, too. If you have $1,000 sitting in your bank account, you can contribute it all today!
This is a great option if you receive a holiday bonus, take on an extra freelance gig, or receive an inheritance or gift. Remember that you’re only allowed to contribute the lesser of $5,500 or your total post-tax income. Gifted money typically doesn’t count as taxable income.
The exception? If you make too much to contribute (that’s over $132,000 per year), you’ll probably be in a similar or lower tax bracket when you retire, so you’re better off taking advantage of a traditional IRA or your company’s 401k.
If you have access to a 401k with an employer match, that’s free money on the table—take it.
Quick review: a 401k is another type of retirement account that you may have access to through your employer . You can contribute up to $18,000 of pre-tax income into this account every year. In retirement, your withdrawals will be taxed according to your income bracket at that time.
An employer match means that for every dollar you contribute up to a certain amount, your employer will contribute a dollar (or fifty cents, or whatever their match is). A common match is 50% of every dollar you contribute up to 6% of your pre-tax salary. So, if your salary is $50,000:
$50,000 x 6% = $3,000
$3,000 x 50% = $1,500
Your employer will throw in an additional $1,500 if you contribute $3,000 to your 401k. That’s $1,500 of free money that you won’t receive unless you contribute.
How to contribute to your 401k:
To find out if you have a 401k with employer matching, look up your benefits package. You can get in touch with somebody from the HR department or ask your boss.
You’ll probably have the option to set up an automatic contribution of some portion of your pre-tax salary before every paycheck. This means your paycheck will be a little smaller, but you won’t have to remember to make a contribution or be tempted to spend that money on something else—or do any tax-related math.
To set this up, start by dividing your yearly goal by 12. If you decide to max out the employer match from our earlier example, this looks like:
$3,000 / 12 = $250 (pre-tax monthly contribution)
$250 – ($250 x 25%) = $187.50 (the same number in post-tax dollars)
$250 pre-tax is equivalent to $187.50 post-tax at a 25% tax rate. This means that you won’t feel the hit of those pre-tax contributions quite as strongly.
Do you have a Roth IRA or employer-matched 401k? How do you save for retirement?