Three Retirement Planning Strategies for Young Adults

Tuesday, September 9, 2014

Saving Now Pays Later

The majority of employers offer sponsored retirement plans- typically a 401(k) or a 403(b). When a new employee signs up for the plan they are commonly faced with three important choices:

1. Roth vs. Traditional Retirement Plan

Employees can often elect to make post-tax contributions to a Roth, or pre-tax contributions to a Traditional plan.  The primary driving factor for this decision is how your marginal tax rate now compares with your expected tax rate in retirement. If your marginal tax rate in retirement is below your tax rate while working, then the traditional option is the way to go. If not, the Roth makes sense. Although it is difficult to predict future tax rates, for most recent graduates in entry-level roles, the Roth provides a good opportunity to begin creating a nest egg positioned for long-term tax-free growth.

2. Investment Allocation

Because of the long-term nature of the money in your retirement account, it makes sense to aggressively allocate these dollars to assets with high expected returns. Typically, this will mean placing the majority of the account in funds that own U.S. and Foreign equities. Most retirement plans offer a list of predetermined mutual funds as investment choices. It is important to consider both diversification and cost when making investment elections. When investing in equities, for example, we advocate broad sector and market cap exposure. Equally important is the fund’s expense ratio. High expenses will negatively impact long-term performance, so it is advantageous to construct an allocation using relatively low-expense funds.  

3. Contribution Amount

Many employers offer to match employees’ retirement plan contributions up to a specific percentage of their salary on an annual basis. Clearly, this can be a significant benefit. At a minimum, it makes sense to contribute enough to take full advantage of the employer match.

As a young, newly employed graduate, it may be tempting to contribute a minimal amount to your retirement plan in exchange for additional disposable income. It is important to remember, however, the power of compounding returns over significant periods of time. A dollar saved today will be worth significantly more at retirement than a dollar saved even 5 years later. The graphic below (click to enlarge) shows the growth of $20,000 invested at age twenty-five vs. five years later at age 30, assuming an 8% average annual return.

compounding interest retirement planning for young adults

The extra five years of compounded annual growth result in an additional $138,700 at age 65. This represents a 47% premium! Assuming these dollars were invested in a Roth, this exponential growth would also be tax-free. Saving early in life can have powerful implications. As a young person, it is important to recognize that you are in a unique position to set yourself up for long-term financial strength.

New on Our Blog

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Brighton Jones LLC), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained on this blog serves as the receipt of, or as a substitute for, personalized investment advice from Brighton Jones LLC.

To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Brighton Jones LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Brighton Jones LLC’s current written disclosure statement discussing our advisory services and fees is available for review upon request.

Brighton Jones is not affiliated with Facebook, Twitter, LinkedIn, Google+, YouTube or other social media websites and we have no control over how third-party sites use the information you share. Please remember that you should never communicate any personal or account information through social media and it is important to familiarize yourself with their respective privacy and security policies.

Pin It on Pinterest