Last week, in our Retirement Planning While in College Blog, we put a heavy emphasis on making sure you have a comfortable nest-egg saved by the time you retire, but left you anxiously hanging without much direction on how to get there. So this week, we proudly present to you a few powerful retirement plans to help get you started:
Some of us are familiar with the term, 401(k), but not too many college students are all that educated on what it actually is. A 401(k) is an employer-based retirement plan that automatically comes out of your paycheck before being taxed. While this means that your money will be taxed before hand (boo!), it also means that you are being taxed on a smaller income (yay!). One of the many well-known benefits of a 401(k) plan is the employer matching contributions, which means some employers even offer to match a specified percentage of your contributions. That’s free money, and that’s not too shabby!
A Traditional IRA is an individual retirement account that lets your earnings grow tax-deferred. This means you pay taxes on your investment gains in the future, when you make withdrawals in retirement. A Roth IRA is an individual retirement account that you fund with ‘post-tax income’ which is a fancy term for income that has already been taxed. So when you withdraw for retirement, there are no taxes to pay. And because every penny that you stash in a Roth IRA is YOUR money, you have the option to tap into your contributions (but not your earnings on those contributions) at any time. So which is more ideal for the young, lower income college student? Look no further than that Roth IRA. They make sense if you expect your tax rate to be higher when you retire rather than your current rate. You’ll benefit from that upfront tax deduction and the decades of tax-free, compounded money. Both Traditional and ROTH IRAs can be used in conjunction with your employer-based retirement plan.
When you think of investing, you probably think of buying stock in one company, waiting for the value of the stock to appreciate, then selling that stock before it depreciates. In order to accumulate wealth in this fashion, one needs a lot of time to sit and watch the stock prices, a commodity in which most college students are lacking. As college students, do we really have time for that? As always, we have an answer for you: mutual funds. A mutual fund groups large numbers of companies together like Starbucks, Facebook, Amazon, etc… and averages all of their growth. This (mostly) removes the gambling aspect of investing. If you hold shares in a fund with fifty companies and one isn’t doing so well, the average of all fifty companies together will still be positive. While the market will go down at times, it always always ALWAYS comes back up. Nothing’s guaranteed in the market, but statistics show a solid growth pattern.
Retirement may feel like a lifetime away, but by starting in college, you give yourself the advantage of many more years of compound interest slowly building your wealth. If you only add $50 each month with an average of 8% compound interest, you will have roughly $2,920 at the end of your four years in college. Congratulations, there’s an extra $500 just for putting that money aside! And that’s only after four years! Keep compounding for thirty years and tell us how pretty that number looks.