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The One Thing Millennials Are Getting RightBy
Monday, May 23, 2016
I hate to say it... but "millennials" are getting something right.
I'm talking about retirement savings. The so-called millennial generation – folks born between 1982 and 2004 – is saving more than past generations. A study from the insurance and investment firm Transamerica showed that today's average 30-year-old started saving at 25, but the average 60-year-old didn't start saving until 35.
But while they're starting earlier, millennials still aren't saving enough... Worse, they hesitate to invest in the stock market or even in retirement accounts like 401(k)s or IRAs. That means their money is just sitting in savings accounts earning nearly nothing.
The recession in 2008 and 2009 changed the way many Americans think about saving and investing. But to build a successful retirement, you need returns higher than 1%.
Today, I'm sharing my best tips for novice investors. These are the lessons I wish I had heard at 20 or 25. And even if you're a seasoned investor, they will still probably resonate with you...
1) Get time on your side.
It seems like common sense – the sooner you start saving, the more you'll have saved by the time you retire. But there's more to it than that. You see, the money you save today can be put to work to make you more money.
It's called the power of compounding.
The money you make increases what you already have as you continue to add more to the pot. The key is that the more years you give to compounding, the more your money mushrooms.
Let's say two investors each deposit $2,000 into an account earning and reinvesting 4% dividends. The first investor (Peter) starts at age 26 and makes a $2,000 deposit each year until he retires at 65. The second investor (Paul) makes his first deposit at age 19, then adds $2,000 a year for the next 15 years.
Imagine their stock portfolios show no share-price appreciation. They just crank out 4% dividends each year. On their 65th birthdays, the two investors compare the balances in their accounts.
Even though Paul only made 15 contributions, he made more money than Peter, who made 40 contributions. The trick is, Paul started seven years earlier than Peter. So on the day Peter made his first contribution, Paul had already accumulated nearly $20,000, and his portfolio was earning more than $2,000 a year in dividends. As you can see, using time to your advantage is a critical ingredient in compounding. The more years you give it, the more your money will grow.
2) Take your employer's money.
If there's one financial decision that every single person needs to make, it's this... Always contribute to your 401(k) if your employer matches it.
Never underestimate the power of a 401(k) account. A 401(k) is a retirement account that your employer sponsors and manages.
Our employer matches half of an employee's contributions up to 6% of salary. That means if the employee sets aside 6%, the employer adds 3%... for a total of 9%. That's an instant 50% return on your money...
In the world of personal finance, skipping out on that free money is the worst possible mistake.
3) It's never too early to start an IRA.
Another type of retirement account – and one that doesn't require an employer to set up – is an IRA. The real benefit to an IRA is the tax savings.
When you put money in a traditional IRA, you get a tax deduction for the initial deposit, and the government defers taxes on the money until you withdraw it, typically sometime between ages 59.5 and 70.5.
Deferring taxes saves more than you think. As longtime DailyWealth readers know, you can use IRAs to protect and compound your wealth tax-free... and generate an immediate 33% return on your investment.
4) Let the feds pay you to save.
Putting money into an IRA is also a way to earn a big tax credit.
The Saver's Credit matches a portion of what you put into your IRA up to $2,000 (or $4,000 if you're married). The credit amount is based on your household earnings.
The tax credit gets bigger for lower income levels. If you make less than $37,000, your credit is 50% of your contribution.
You can also choose to set up what's called a Roth IRA. This works like a traditional IRA, but you pay taxes on the money before you deposit it. Then the IRS won't tax future withdrawals.
5) Make money off your health savings.
Health care plans in the U.S. are pricey. We can't have 100% coverage with no deductibles.
So there are plans called "high-deductible health plans," or HDHPs. These work by letting you pay lower premiums but pay more of the early costs. So you're not shelling out for every possible test and procedure you probably won't need. They come with high deductibles plus out-of-pocket expenses... The deductible minimum for individuals this year is $1,300.
To increase the benefit, set up a Health Savings Account (HSA) with your HDHP. An HSA works by allowing you to bank pre-tax dollars. You can then use that money to pay for health expenses. Best of all, there are no use-it-or-lose-it rules.
I recommend making the maximum contribution ($3,350 per year for individuals and $6,750 for a couple). If you can't afford that, try taking your deductible amount and dividing it by the number of paychecks you earn each year. That way, after one year, you know you'll be able to cover the full deductible if any emergencies crop up.
And here's the big loophole... The IRS allows you to use your HSA like a garden-variety IRA. You can just keep putting money in it until age 65. Once you hit 65, you can withdraw the money without penalty for any purpose... You'll just have to pay taxes if it's non-medical.
If you have any children or grandchildren ready to start learning more about investing, please pass along this essay. It's never too early to start taking advantage of retirement accounts, and there's nothing better than starting loved ones on the road to taking charge of their own financial future.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Further Reading:
Worried about the state of the economy? Doc says you shouldn't be. "The typical American consumer's wallet is healthier than it has been in a long time," he writes. Get the full story here.
It's the question Doc dreads the most. But a simple three-step criteria can give you the answer you need. Read more here: If You Ask This Question, You're Jeopardizing Your Retirement.
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