I received the following email from Chelsey, a recent college graduate just starting her career. Chelsey has an emergency fund in place, and is interested in saving for retirement, but hit a snag when her new employer didn’t offer a 401(k) plan.
“I’m 22 years old, just graduated from college. In a few weeks I’ll be starting a new job. It’s very entry-level, so I don’t have benefits or a 401(k) plan. I’m wondering if I should find some other kind of retirement account or what I should do. I don’t understand 401(k)s at all or even know what a Roth IRA is. What would you suggest someone in my position do?”
- Chelsey
First of all, congratulations on finishing your degree. I’m impressed that you are even thinking about this stuff at 22 years-old! I sure wish I had been thinking like you at that age. Your dilemma is not uncommon for people just starting out in a career, but just because your employer doesn’t offer a retirement plan certainly doesn’t mean you can’t begin planning for your own retirement now. When I was in my early twenties I took some time off from school to work a variety of jobs, and none of them offered benefits. I figured since I didn’t have access to a 401(k) I just wouldn’t pursue investing for my retirement. Besides, that was decades away and I needed money now. I lost a few years of potential compounding growth to that lazy way of thinking.
Without the benefit of a 401(k) at your new employer you would be wise to investigate other options for retirement savings such as the Roth IRA. A Roth IRA is basically an individual retirement account that allows you to contribute after-tax dollars. The earnings may be withdrawn tax free after you reach the standard retirement age (currently 59 1/2). Your contributions to a Roth may be withdrawn at any time without penalty.
Roth IRAs are offered through most banks and brokerages, and places like Vanguard, Fidelity, T. Rowe Price, and TIAA-CREF have solid investment options, and are among some of the lowest cost providers. Each brokerage website also offers updated information on contribution limits, income eligibility, etc. For more information, read How to Open a Roth IRA at Vanguard.
A few brokerages have steep minimums for initial investments. If you find this to be the case with a fund you are interested in simply save in an account at ING Direct, or similar high-yield account, until you have enough to saved to start investing.
In addition to online research, I’d recommend checking out the book The Bogleheads’ Guide to Investing, which is one of the better primers on investing. As for the selection of individual funds, well, that is a personal choice based on your level of risk tolerance. Whatever you do, don’t select funds based solely on something you read here, or anywhere else for that matter. Only invest in things you understand, and move slowly to make sure you fully understand a fund’s objective, its top holdings, its fee structure, etc. You are well on your way to building wealth for the future.
I know many readers have been in similar situations when starting their careers. What’s the single best piece of advice you would give Chelsey?
I began saving for retirement while still in High School. Sounds strange, but this was in the late 80′s and I had a part time job (full time in summer) that paid $20/hr. I was able to take risks with my money and not face ruin since I lived at home and had already paid cash for my Jeep. I was lucky also that I lived in Canada where we are able to contribute to a ‘Registered Retirement Savings Plan’ (RRSP). We can use pretax dollars to invest and gain a considerable tax benefit. The money is allowed to grow tax free inside the fund (self directed investments or bank investments) and is only taxed when you pull it out…at retirement hopefully…and thus would be taxed at a lower income rate.
Basically I maximized my RRSP contribution each year (and continue to do so now despite having a good pension plan where I work) and I used the tax refund I got each year to pay my tuition and to travel for each entire summer.
My point is that regardless of the situation, the reader needs to start something now, and can be a little more tolerant of risk and thus bring higher returns.
That would be for the short term. Over the medium term I would recommend that she either presses her employer to start a 401(k) or move on to an employer that does…although making sure she is paying attention to the entire compensation package – salary, health plan, vehicle allowance, 401(k)…etc.
Definitely open a Roth IRA as suggested. You can contribute $5,000 per year now (you have until April 2009 to contribute $5,000 for the 2008 tax year). Even if your employer did have a 401(k) some people would suggest funding a Roth instead, especially if your 401k didn’t offer a match. If you open it with Vanguard (that’s where I have mine) it is very easy. Just set up an automatic withdrawal ($50 or $100 isn’t too little per month) and I’d suggest putting it all in the total stock index fund since that means your investing in everything. If you have low tolerance for risk you’d put some – like 20 or 30% in bonds. If you really aren’t sure at all what you are doing you can stick it in a money market fund where it won’t loose any money but won’t really gain much either. That can buy you some time until you figure everything out! Also, they have really good phone reps who can help you out.
Start early, leave it in there, and don’t take it out for anything!!!! Reap the rewards of compounding interest over the years!
We only have one child, so are contributing to a Roth IRA based on his earnings. Next year when he is 21 we will have contributed 25 thousand dollars. Even if he doesn’t contribute any more it should be worth quite a bit in 40 years. All parents should consider this as it gives the child a head start. Forget my parent’s attitude, “I had to struggle starting out, you should too”.
Jason,
Thanks so much for responding to my question! I am excited to hear what your readers have to say.
My biggest advice, beyond figuring out which type of account to set up, is to maintain your “college lifestyle” as long as possible. People tend to live quite frugally during their college years and the longer you live with roommates, low rent, and generally low overhead, the more able you will be to start to build your nest egg early.
I also highly encourage you to invest in a Roth IRA. Even if it means you have to cut back in other areas now, you’ll be so much better off later on in life. Like Sandy has said, live frugally now. Save what you can for both an IRA and an emergency fund. I personally like the Vanguard line of index funds for IRA’s.
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I’m in a similar situation to Chealsey: I’ve recently graduated and taken a job working in a school district that doesn’t offer a 403(b) plan. However, I’ve already maxed out my Roth for 2008, and I’m not sure where to begin when it comes to researching options for taxable accounts. Any suggestions?
My advice is that once you start contributing toward your retirement, don’t stop and then restart the contributions. I used to do that when my expenses got high (usually around Christmas) and resume several months later and rarely at the same amount (I’d lower it). I’m certain I’ve lost years of investing opportunity. Had I kept at it consistently, I’m certain my retirement would be substantially higher than it is now. Also, each time you get a raise or pay increase due to changing jobs, put the difference toward your retirement as soon as possible. This way you won’t adjust your spending upwards and then feel like you have to maintain your new habits. Nothing will change except your retirement fund. And it’s really fun to watch it grow. You’re smart to think about this so soon. I wish I’d been as insightful so young. I had credit cards instead at your age. Good luck, and maybe we’ll see you blogging about becoming a millionaire at 40!
To Almost There, your post inspired me to look into Roth IRAs for my kids (5 1/2 and 3). They’re too young for it now, but when they start working as teenagers, I’m going to encourage them to open their own Roth IRAs and offer a 100% match. I just ran some numbers really quick, and figured out that for contributing just $400/year (including our match) for just 10 years (from 15 to 25) at 9%, would yield $130,057. Not bad for a $4000 investment! Your son is lucky – his retirement is off to an excellent start. Thanks for your post and helping me put this on my agenda!
Way to start this early on something like retirement. She will definitely see that pay off in a big way when she does retire
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Re: Letter From Chelsey
With Socialist Insecurity Day on August 14th, just wondering if you advise young working people to the potential fraud in their future, should they not live to collect any Socialist Insecurity benefits, or have no eligible survivors.
Sadly, politicians & proponents of the biggest Ponzi scheme in history, have sold working America a bill of goods, stressing the `glorious` benefits of this political scheme, but no one dares to address the risks.
No one will mention how FICA payers lose their `contributions` to the government, should they become victims of the FICA Death Tax. In the real world, operators of private sector Ponzi schemes could face long-term sentences, ala, Bernie Madoff, unlike corrupt politicians, who face long-term incumbency, for perpetuating risky Socialist Insecurity.
So, let the revolution begin, again…no more FICA taxation, without representation. Remind working Americans, especially young people, how their 10th Amendment rights are being trashed by corrupt politicians.
Harry Thompson
Tucson, AZ