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Whaaat? We’re talking about a retirement account??
Oh, yeah. It might seem crazy, or even a little paranoid to start thinking about retirement so early, but there are reasons for it. Rock solid reasons. So first, let me explain why you need to open this account so young, and then I’ll walk you through the steps of it so you can get started right away.
Why Should I Open A Retirement Account?
Well, for one thing, you’re a millennial.
Millennials aren’t going to have pensions and social security like our parents and grandparents have or had.
For social security, it has to do with a big flaw in the system. About 12% of your income (half of that paid by you, half by your employer) goes toward it. However, it’s not going to YOUR social security, it’s going to one giant fund that everyone uses. When anyone retires, becomes disabled, etc., they take from that big fund. This would work fantastically if the population stayed the same. And, more importantly, if general percentages of who’s working and who’s not stayed the same. But they don’t. So right now, the number of people working is shrinking and the number of people needing the money is increasing.
Pensions are different. A pension is a setup for retirement paid by your employer that’s based on how long you’ve worked there, your salary, etc. The longer you worked there, usually the more money you’d get from them in a monthly check when you stopped working. However, companies decided that wasn’t sustainable either. They wanted to cut costs, so they replaced pensions with 401(k)s. The difference is that you put into a 401(k), and your employer matches a percentage of it. And that percentage varies employer to employer, but it’s usually shitty. *Coincidentally* around the time employers stopped offering pensions, people started switching jobs a lot more than they used to.
The point is, these two retirement security blankets won’t keep millennials safe and warm when we’re old. We kind of have to fend for ourselves. Millennials need to take a much more active role in our retirements than previous generations!
And the second thing is, you’re a millennial!
That’s not a mistake, being a millennial is the first and second reason! If you’re a millennial in 2017, you need to start a retirement account either today or yesterday, otherwise you’re losing money. You see, there are two different kinds of interest. They’re called simple and compound.
If you put $100 in a bank account with a 5% simple interest rate, you’d get $5 extra every month in interest, no matter how much more money you put in there. You always get the interest from the first amount that you put in. After a year, you’d have $60 (5% of $100 x 12 months) in interest, even if you put a million more dollars in there in that year, because it’s based on the principal amount you put in.
But then there’s compound interest, which is what you get with a retirement account, and we like that kind more. A compound interest rate is based on the amount of money that’s in your account. So, if you put in $100 at at 5% compound interest rate, you’d start out the same with $105. BUT THEN! If you put in $900 more so you have $1,000 in your account, your 5% interest is $50! If you get that account up to $10,000, that 5% means $500 extra. So, with a retirement account, it pays to start early because more time to put money in means more money in the end.
Here’s a famous chart that exemplifies that in an extreme way:
I got this chart from Dave Ramsey’s site, though I’ve seen it many times in the past couple of years. What you’re seeing is two people who both contribute $2,000 per year to their retirement account. They also both have an equal, 12% compound interest rate. Ben invests his first $2,000 when he’s 19, and continues to do so until he’s 26. But then he stops! Compound interest alone carries him from $16,000 all the way to over TWO MILLION DOLLARS when he turns 65.
But look what happens to Arthur, who doesn’t start his retirement account until the age Ben stops contributing. And, he NEVER stops contributing until he retires. Since he missed out on those beginning years, he missed out on those last few years with the largest amount of interest. His return is still great, with an investment of $78,000 turning into over $1.5 million, but it took more time and more money for a smaller return. So, that’s the second reason being a millennial (basically I mean “in your twenties”) is a great reason to start a retirement account.
A third reason to open an account is that there are tax benefits.
There are two main different types of retirement accounts. The first is a Roth IRA (Individual Retirement Account) and the second is a Traditional IRA. They both have different tax benefits, and the one you choose depends on your particular situation.
The tax perk for a traditional IRA is that you can get a tax deduction every year that you contribute money to your account. However, when you pull the money out at retirement time, it’s taxed at regular rates as if it were income. With a Roth IRA though, there aren’t any tax breaks along the way. But then in the end when you take the money out, you get the entire sum, tax-free!
When you’re in your twenties, it’s usually better to go for the Roth IRA because the tax perk is most likely better for you. Right now, are you making what you hope to be making when you’re ready to retire? Probably not. So, if you plan on making more, you’ll be in a higher tax bracket, and they’ll take a bigger chunk of your earnings when you take it out. If you get even some of your taxes out of the way while you’re in this lower tax bracket, you’re saving.
Your own retirement account is also a way to have more freedom regarding your investments.
There’s a perk to an IRA that you don’t get with any of those employer-based plans. You can invest your money anywhere you want. Yup! Even with a 401(k), where you can invest on your own a little, you’re often limited to the options offered by your employer. And with a pension, you can’t invest on your own at all. So, when you open an account that’s entirely your own with no one else involved, it is completely up to you what happens to it. You don’t have to put it where your boss says to put it, and you certainly don’t have to share it with anyone else like you do with social security contributions.
The benefit to this is that you can be as conservative or aggressive as you’d like. You could let it sit if you wanted to, or you could trade every day. This was a huge relief to me, who has absolutely no investing knowledge whatsoever. It might be interesting to play around with my money a little someday and see what happens, but for now, I can just rest assured it’s safe and mine.
How to Start a Retirement Account
Alright. So now that I’ve convinced you that you should totally open a retirement account, I’m gonna tell you a bit about starting one. Personally, I have a Roth IRA with TD Ameritrade. I’m receiving no compensation for writing about them. It’s just my personal experience, so that’s what I have to share with you guys! I am going to tell you why I chose it though.
Nerdwallet has a great chart that compares a few of the top IRA providers. It tells you the highlights of what they offer, how much it costs to trade, account minimums, etc. I was stuck between Merrill Edge and TD Ameritrade, because neither had an account minimum, the trades cost the same, and they’re both big names with stellar reviews. Ultimately, I went with TD Ameritrade because they offered a giant database of educational resources to learn more about investing. Also, I have a friend who’s a big shot money guy and he had good things to say about them.
So, Nerdwallet was the chart I was looking at when I made my final decision, and they had buttons that took me directly to where I could open an account online. I needed about a half hour of my time, my SSN, and my employer’s name and address. Everything else was information I knew off the top of my head like where I work and how much I make. The most complicated part was when they asked questions about what types of investments I saw myself making. Since I have no experience trading whatsoever, I used Google, and I gave answers that made other drop-down menus full of big money words disappear.
So, that’s the gist of it!
I’m definitely still learning myself, but I can absolutely answer or find answers to your questions if you drop ’em in the comments. Opening a retirement account is something I know you’ll be eternally grateful for someday. And, learning this stuff about personal finance is one step closer to being an actual adulty-adult. Not just a kid that looks like a grownup. I hate that feeling, which is why I’ve dedicated myself to this journey I share on Uninspired. This blog is all about striking a balance between having fun and building for your future, and I’m so excited you’re on the journey with me.
Also, now that you’ve done all this adult-y money crap, go reward yourself. Read this much more fun post full of crude and hilarious pickup lines. Who says you can’t be an investment mogul with an affinity for crude humor? It’s all about the balance.