5 Retirement Planning Rules For Recent Graduates
Young people just starting out may not know where they are headed in terms of a career path. However, that doesn't mean that they shouldn't plan for retirement. In fact, the following are some issues that newly minted graduates or recent entrants into the workforce might want to think about.
Rule No.1: Line Your Own Pocket First
It's OK to go out and have fun with your friends and enjoy things such a latte from time to time. But it is equally important for young workers to be disciplined from the start when it comes to saving a portion of their paychecks for retirement and an emergency fund.
Ideally, if the individual can afford it and it is available, they should consider contributing to their company's 401(k) plan. But even outside of such a plan individuals might attempt to accumulate a savings of after-tax money. The reason for this is that 401(k) savings are generally not meant to be touched until later in life. Tapping such accounts will reduce the amount of money the individual has when he or she retires. Withdrawal will mean losing not just by the amount withdrawn, but also the potential interest that money would have earned. In addition, there may be tax liabilities and penalties for early withdrawals.
In short, individuals should focus on setting aside or saving at least 5%, and preferably 10% or more, of their income. Doing so in early years will enable you to amass a larger nest egg and hopefully enjoy a worry-free retirement. (Read Starting Early With Financial Planning for more.)
Rule No.2: Take Advantage Of A 401(k)/Roth
Workers whose companies match 401(k) contributions should strongly consider taking advantage of them. After all, it can be a tremendous benefit and allow the worker to build a nest egg at a much faster rate.
In addition, a Roth IRA can be a great way to set aside money for retirement. In 2010, individuals under 50 are eligible to contribute up to $5,000. Those over 50 can contribute a total of $6,000. The best part: contributions that were made could be withdrawn tax-free. (Learn more in our Roth IRAs Tutorial.)
Rule No. 3: Be on the Books
While it may be tempting to work "off the books" for cash, doing so may have an adverse impact on an individual's future. Generally, employees who work off the books don't have access to company retirement plans. In addition, and this is extremely important, the individual won't be paying taxes, and therefore contributing to Social Security. This will impact how much Social Security income they are eligible to receive when they retire.
Rule No.4: Make Pretax Contributions for Benefits/Services
Some companies offer their employees the chance to set aside money pretax to cover some commuting expenses or childcare costs. This can be a terrific benefit and can save the employee a great deal of money every year.
Ask your human resources team if such plans are available at the company and what it takes to enroll. A word of warning though: money set aside must generally be used. In other words, if an individual has $1,000 deducted from his or her paycheck each year pretax for commuter expenses, he or she must generally use or lose that money. This can be a great way to save money, but at the very least, it's worth further investigation. (Learn more in Employee Benefits: How To Know What To Choose.)
Rule No. 5: Know the Rules
Don't undermine yourself by withdrawing money from a retirement plan too early. If the plan holder withdraws money before age 59.5, there could be taxes owed or penalties triggered that will deplete the individual's nest egg.
According to the IRS website: "Distributions received before age 59.5 are subject to an early distribution penalty of 10% additional tax unless an exception applies." In short, that type of penalty could be particularly punishing, especially if the distribution was quite large.
Speak with the company's human resource team and a certified public accountant prior to making withdrawals. It's always better to know all of the potential liabilities and rules beforehand.
Incidentally, individuals should be aware of their employers' policies on things such as 401(k) matching. Taking advantage of matching could seriously boost savings over time. Again, this is something that the company's human resources representative should be able to help out with, but you may have to ask. (For more, see Five Ways To Lose Your Nest Egg.)
The Bottom Line
It's easy to become overwhelmed when one first enters the workforce. Trying to plan a career path, dealing with office politics and the rigorous hours can seem like a full-time job all by themselves. However, that doesn't mean that new entrants into the workforce shouldn't think about retirement.
With all of that in mind, prior to making any large decisions regarding retirement it is best to research the matter and consult with an advisor and a tax professional. Every individual's situation is different. (To learn more, check out our Investopedia Special Feature: Individual Retirement Accounts.)