Most young adults can’t imagine their wrinkled, old, future selves, so many don’t worry about retirement—this is a big mistake because time is probably the most important investment tool you have in your retirement arsenal. Don’t worry if you haven’t pondered much on retirement—you’re not the only one! I am writing this article in hopes of helping you get started on your retirement journey.
One of the best ways to kickstart your retirement savings is through an Individual Retirement Account (IRA). There are several different types of IRAs.
Roth IRA
For young adults, a Roth IRA often emerges as the top choice due to its numerous advantages. Contributions to a Roth IRA are made with after-tax dollars, meaning they won’t be tax-deductible, but the earnings within the account grow tax-free—this translates into potentially tax-free withdrawals during retirement. Since young adults are likely in a lower tax bracket than their future selves, paying taxes upfront can be advantageous. Additionally, Roth IRAs have no required minimum distributions (RMDs) during the account holder’s lifetime, providing flexibility and potential estate planning benefits.
Traditional IRA
While Roth IRAs tend to be more popular among young adults, a Traditional IRA can still be a viable option depending on individual circumstances. Contributions to a Traditional IRA are tax-deductible, potentially lowering your taxable income in the year you contributed. The earnings on investments grow tax-deferred until withdrawals are made during retirement. If you anticipate being in a higher tax bracket during your working years and expect to benefit from the tax deduction, a Traditional IRA may be suitable. However, remember that withdrawals from a Traditional IRA are subject to income tax at the time of distribution.
Employer-Sponsored 401(k) or 403(b) Plans
While not strictly an IRA, employer-sponsored retirement plans such as 401(k) or 403(b) plans offer valuable retirement savings opportunities for young adults. These plans often include employer matching contributions, providing free money toward your retirement. If your employer offers a match, it is generally advisable to contribute at least enough to maximize the match before considering an IRA. Contributions to these plans are made pre-tax, reducing your taxable income, and the earnings grow tax-deferred until retirement—similar to a traditional IRA.
SEP IRA
A Simplified Employee Pension (SEP) IRA is designed for self-employed individuals and small business owners. It allows them to contribute a percentage of their income to a retirement account. Contributions to a SEP IRA are tax-deductible and grow tax-deferred until withdrawals are made. SEP IRAs offer higher contribution limits than Traditional and Roth IRAs, making them an attractive option for those with significant self-employment income.
Consider a Hybrid Approach
Young adults can open multiple IRAs and may want to consider a hybrid approach by combining different retirement savings options. For example, you can contribute to an employer-sponsored plan to take advantage of the employer match and contribute to a Roth IRA to benefit from tax-free growth. This strategy allows for both immediate tax advantages and long-term tax diversification.
Which IRA is right for you?
The best IRA for you will depend on your circumstances. A Roth IRA may be a good option if you’re in a low tax bracket now and think you’ll be in a higher tax bracket in retirement. A traditional IRA may be a good option if you’re in a high tax bracket now and think you’ll be in a lower tax bracket in retirement. Whatever type of IRA you choose, it’s essential to start saving early—the sooner you start saving, the more time your money has to grow.
Here are some additional tips for young adults saving for retirement:
- Set a goal. How much money do you want to have saved for retirement? Once you know your goal, you can create a plan to reach it.
- Start today by setting up an IRA at a brokerage. Brokerages such as Charles Schwab, Interactive Brokers, and others make it reasonably easy to set up IRAs. Setting up a brokerage account can take less than 30 minutes if you have all your information handy.
- Make regular contributions. Even if you can only afford to save a small amount each month, it will add up over time.
- Invest wisely. Choose investments that have the potential to grow over time.
- Review your portfolio periodically. As your investments grow, you may need to rebalance your portfolio to ensure it still aligns with your goals.
- Get help from a financial advisor. If you’re unsure how to save for retirement, a financial advisor can help you create a plan and ensure you’re on track.
Starting to save for retirement early is one of the best things you can do for your financial future. Following these tips increases the probability of a comfortable retirement.
