Ever gotten into the car and started driving before you knew your destination? If you have, you know what it’s like to start planning your personal finances without knowing what you want for your financial future.
Your situation could use financial advice tailored to your needs, but here are a few useful tips to get you started.
Let’s take a step back to our initial car analogy and start by identifying your destination. Where do you want to be at the end of the road? It’s never too early to start saving for retirement and that’s not just because starting young means you can save in small but steady increments. Saving in early adulthood also allows compound interest to accumulate year after year.
Use our retirement income calculator to estimate how much you should be setting aside each year to secure a comfortable retirement.
If your employer matches your retirement contribution, one of the easiest ways to start growing your retirement savings is by meeting your employer’s highest contribution match. If your employer doesn’t offer this option or you’ve already maxed out on your annual retirement contributions, the next place to look is an individual retirement account (IRA).
There are benefits to both traditional IRAs and Roth IRAs, but the primary difference is a traditional IRA is tax-deferred, whereas a Roth IRA is not. When you reach retirement, you’ll still owe income taxes on the money you saved in a traditional IRA. But since you may be in a lower tax bracket in retirement than when you initiated the savings plan, you could pay less in taxes than you would have with a Roth IRA. This option is beneficial for those who have already maxed out on their employer contributions and are looking for other ways to grow their retirement funds.
With a Roth IRA you pay income taxes on your savings in advance, so when you cash into those funds during your retirement, you keep all of the money. This option is beneficial for young adults just starting their careers who foresee advancing into higher income brackets later in life.
Because IRAs are taxed as income, it’s beneficial to estimate how much your retirement savings will amount to when you cash in on them. A Roth IRA makes sense if the amount puts you in a higher income bracket than the one you were in when you started saving for retirement.
It’s a question most savers ask themselves: Does it make more sense to save money now or pay off debts? Unfortunately, the answer is not black and white; you should strike a balance between paying off as much as possible while still maintaining enough in an emergency savings fund to keep from needing to take out additional loans.
But what about long-term savings?
If we do the math, paying off a credit card balance with a 15% interest rate will earn you more money than making a deposit in a savings account with an 8% savings rate. However, there are several dilemmas that arise from not starting your retirement savings until later in life; the first of which is you lose the most valuable savings account benefit: time.
Compound interest is how your retirement savings grow, so even small contributions early on will make a difference in the long run. You might think you can’t afford to start a retirement savings fund; that doesn’t negate the need to start one. Paying down debt ahead of schedule has a guaranteed rate of return, but putting off retirement savings until you feel like you can “afford” it can leave you playing catch up in the later years of your career.
The best way to stay on top of your personal financial plan is to start an emergency savings fund that will keep you from needing to put yourself into more debt. Consumer debt typically has the highest interest rates. If an emergency leaves you needing to dig yourself deeper into debt but you’ve already poured all of your money into your IRA or onto your car loans, you’ll end up losing money by taking out more loans than you would have had you set cash aside in advance. A good rule of thumb is to set aside enough to cover you for three to six months.
Let’s say that after all your monthly expenses were paid you still had $1,000 in your pocket. How can you make the most of it? Ideally you should divide it between your retirement savings account, emergency savings fund, and existing debt payment. The percentages for each amount depend on your personal financial plans, but debt repayment should take the lion’s share, your emergency savings fund should be replenished as needed, and the remainder should go to your retirement savings fund.
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