If you’re like many young adults who’ve recently entered the workforce, you may view retirement as a distant dream. Regardless of how far away retirement may seem, the investments and financial choices you make early in your career may be more impactful on retirement savings than you think. And if you’re worried about how much you’ll have to contribute, this is all the more reason to start saving early – while time is on your side for compound returns and tax management.
Tax Management
One of the first things young adults notice when they receive their first paycheck is how much of their earnings have been taken as taxes. While taxes are a part of life, there are ways to manage your taxes through practical retirement savings.
Workplace retirement plans can lower taxes now
Typically, contributions you make to 401(k) or other workplace retirement plans are pulled directly from your paycheck before taxes. That means you’re not only squirreling away money for your future but potentially lowering the taxes you owe for the current year due to lower taxable income.
Some retirement savings plans provide tax-deferred compounding
The retirement savings plan that you choose can potentially provide tax-deferred savings growth. For example, if you contribute to a traditional IRA plan, the funds are not taxed until you withdraw them. That means your contribution can grow through interest earned on the entire balance of your investment rather than the amount that remained after taxes.
Potential for future tax-free income
While Roth plans don’t offer immediate tax benefits since they’re taxed as they go into the plan, qualified distributions are tax-free. Typically, qualified distributions are withdrawals made after you’ve had your Roth plan for at least five years, are 59 ½ or older, or become disabled or passes away. However, always check your specific policy before requesting a distribution to ensure you meet all the guidelines.
Compound Returns While Time is in Your Favor
Beyond tax management, getting a head start on retirement allows you to begin earning compounding returns. When you contribute to an interest-bearing account, you earn a percentage based on the annual percentage yield and balance held in your account. When interest earned is deposited into the account, you are essentially earning interest on interest. The earlier you start with your retirement savings, the more likely those savings are to gain momentum through compounding returns.
For example, if someone puts $1,000 in an investment that earns 5%, or $50, in year one, which gets reinvested, bringing the total to $1,050. In year two, that money earns another 5%, or $52.50, resulting in a total of $1,102.50. Year three brings another 5%, or $55.13, totaling $1,157.63. Each year, the earnings grow a little bit more. Over the long term, the results can snowball significantly.
Ready to Start Planning Your Financial Future?
As a young adult just entering the workforce, you have options to help lay the building blocks for a long and fruitful retirement. If you’re unsure where to start, meeting with a financial planner to discuss your long-term goals and risk appetite can help you confidently navigate retirement savings.
Learn More about Retirement Planning
Learn More about Larry Davis, Financial Advisor Near Rochester, MI
About Larry Davis, CERTIFIED FINANCIAL PLANNER™
Larry has been active in the financial planning field since 2004 and is the founder of Davis Capital Management. As a well-known financial planner in the Southeast Michigan area, he works primarily with small business owners, post-divorce planning, and people transitioning from their working years into retirement. Davis Capital Management is located in Shelby Twp, just minutes away from Rochester Hills.
Through his experience he has developed and refined wealth management processes including the PET FORMula™. He is an active member in the Financial and Estate Planning Council of Macomb County. Larry is also actively involved with the Rochester Chamber of Commerce. He resides with his wife and three children in Washington Township and feels very blessed to be a part of this community.