It is never too early to start planning for your retirement and financial independence. We all want to have a comfortable amount of wealth once we leave the work force to pursue other activities like volunteering, golf, and travel without the constant worry of running out of money. Fortunately, you can incorporate some of the strategies below while in college and leave your 60-year-old self very happy!
The most common investment accounts to kickstart your retirement funds are IRAs, 401(k)s, savings, and brokerage accounts. They all have their own pros and cons, and a combination of them is best for most people. Listed below are the main advantages and disadvantages for each to help you weigh which one is most appropriate for your particular situation and goals.
- Details: contributions in this account are after-tax (i.e., using money you have after paying your annual taxes), but any withdrawals after age 59.5 are tax-free. You can only contribute earned income (e.g., wages, tips, salary) and the contribution cannot exceed $6,000 and may be less if you are in a high enough income bracket. You can invest in a wide range of products in any IRA.
- Best use: If you predict your income in retirement to be higher than your current income and want to protect against future tax hikes.
- Details: Similar restrictions to a Roth IRA but contributions are pre-tax (i.e., using money that has not been taxed yet for the year; these contributions may help lower your taxable income and overall tax liability) and can help lower your current tax burden, while future withdrawals after age 59.5 will be taxed.
- Best use: Lower your current tax burden and grow your investment tax deferred.
401(k) or 403(b)
- Details: Usually an employee-sponsored plan that enables you to contribute part of your paycheck into curated investment options (less options than those offered in IRAs). If you get an employer match, then you should always max it out (i.e., you contribute $1000, and your employer agrees to match that amount, resulting in $2000 in your account). The current annual contribution limit is $19,500. There are both Traditional and Roth 401(k)s with the same tax dynamics as IRAs.
- Best use: Maximizing “free money” from your employer if match offered and tap into the company retirement plan.
- Details: Most people have a savings account as it is a great option for learning to save money rather than to spend it. You can open one through any bank and it acts as an entity to store money with minimal interest accruing. There are withdrawal limits as this is not an account to be used for everyday purchases.
- Best use: Serves as an emergency fund, store of money, and extremely low-risk entity.
- Details: This account can be opened through any major financial institution (Chase, Bank of America, Schwab, Fidelity, etc.) and allows you to trade securities like stocks and bonds. Many of them have low minimum account balance requirements (<$1000) and provide very inexpensive investment options. Yes, $1000 might seem like a lot to a college student, so you may need to put money into a savings account until you reach the minimum. A brokerage account does not offer any special tax benefits.
- Best use: Flexibility in investments through stocks, bonds, mutual funds, etc. Also, very useful if you have maxed out tax-advantaged accounts like IRAs and 401(k)s.
Which account should you invest in first?
In general, it is best to put any earned income that you do not need into an IRA account (either Traditional or Roth, whichever you prefer). This could be as simple as putting $50 you earn from working at the WPEC or SAAC into your IRA account by transferring the money from your checking/savings account into your IRA account. Small contributions add up over time and become very large over decades (I know it is hard to think more than a week out, but time has a special compounding effect).
After securing your first full-time job after college, your employer will likely offer a 401(k) plan with preset options and possibly employer matching. Always contribute up to the employer’s match, but if no match is given then feel confident in investing further into either your 401(k) or IRA because of their unique tax advantages.
A brokerage account should be considered if you have extra money to invest after maxing out your IRA and 401(k) contributions since it has no tax advantages.
When investing in any of these accounts, always be wary of your risk tolerance and of the potential for your investment to go down. With that said, it is imperative that you invest your money with a long-term horizon to reap great benefits in the future. The power of compounding becomes increasingly powerful the longer you invest your money.