Getting started.... Your 20s and early 30s

Early in your career is the perfect time to start a habit of saving for retirement because you have one huge advantage you’ll never get again…TIME.

A dollar invested early in life can grow, through the power of compounding, far larger than the same dollar invested later in life.

Say you open a tax-deductible Individual Retirement Account (IRA) at age 25 and invest $100 a month until age 65. If the account earns eight percent a year, you’ll earn $181,252 more by age 65 than if you wait until age 35 to start saving the same $100 a month.

You may shake your head at the recommendation of setting aside money for something you won’t need for 30 or 40 years, especially if you’re still paying off college loans, trying to save money for a home or just enjoying spending your first real paychecks. Remember that every little bit helps.

Even lower-income taxpayers have a new incentive to contribute to an IRA. For each dollar they put in, up to $2,000, they receive a 50-cent tax credit on each tax dollar they owe, up to a maximum tax credit of $1,000 (you must have a tax liability in order to receive the credit).

Look at it this way: you’re buying retirement on the installment plan, and the sooner you start paying toward it, the less retirement will cost you.

Investing opportunities
So where can you start investing for retirement? Most likely, it will be through an employer-sponsored retirement plan, such as a 401(k), that depends mainly on you having money automatically deducted from your paycheck on a pre-tax basis. As noted earlier, fewer and fewer employers are offering defined-benefit plans.

Try to save at least 10 percent pre-tax income in the plan, up to the limit the plan allows. If 10 percent is too much on a tight budget, a smaller percentage can still make a dramatic difference.

If the employer matches your contributions—say 50 cents or $1 for every dollar you put in—try to contribute at least enough to maximize the match—typically up to six percent of your salary. Saving six percent with a six percent matching means you earn 100 percent return on your money!

What if your employer offers no plan? Your options are more limited. The only tax-deductible option is through an IRA, and you can only put up to $3,000 annually into one through 2004 (up to $6,000 as a couple), with additional increases after that. But you can put unlimited amounts into after-tax choices including variable annuities (whose earnings grow tax deferred), stocks, mutual funds and other investments.

If you’re self-employed, you have more tax-deferred choices. You can open a simplified employee pension (SEP) or Keogh plan.

What types of investments should you choose? That depends on several factors, including your tolerance for risk, your overall financial situation, job stability and so on. In general, however, at a younger age, you can probably afford to invest as aggressively as you’re comfortable with, say most investment experts. You have the time to ride out the inevitable market downturns.

CAUTION: Don’t cash out your 401(k) or other employer-sponsored plan when you change jobs. Younger workers often do this because the amounts are small and they want the money to buy a new car or other purchases. You’ll pay income taxes and a penalty tax on the withdrawal. In addition, you’ll lose the ability for the money to grow tax deferred. So, roll it over into a self-directed qualified retirement plan.