Adulting In The End: Planning For Retirement As A Young Adult

If you grew up like I did, no one really talked about planning for retirement or how to manage your money as you transitioned into your adult years.

I suppose you are a recent graduate or a young adult who is ready to start planning for retirement. In that case, it’s important to familiarize yourself with popular retirement terms such as the ones below.

Start Planning For Retirement As A Young Adult

Let’s first define some of the terms you will see throughout this article. Then we will discuss how it all comes together as we discuss the retirement order of operations. Quickly though, I want to express that this is not explicit financial advice. I am not your financial advisor. This article is solely here to serve as an educational starting point for you to begin your research into building your retirement plan.

Alright, let’s get started!

Popular Retirement Terms and Their Definition

401(k)

A 401(k) is probably the most common retirement savings account you hear people mention. It is definitely something you should aim to become familiar with as you begin your planning. A 401(K) is usually an employer-managed account where employees can contribute a portion of their salary. The monetary contributions to this account are pre-tax, meaning they are deducted from your salary before taxes are deducted.

This allows for tax-deferred growth since investment in your 401(K) is not taxed until you withdraw the money from the account.

Additionally, some employers may offer a matching contribution up to a certain percentage. This means that if you contribute a certain amount to your 401(k), your employer will also contribute a portion, essentially giving you free money toward your 401(k).

Now, there is a limit to how much you can contribute to your 401(K) each year. As of this article, the contribution limit is $23,000. Now, as a young person, you likely don’t have $23,000 that you can afford to lock away into an account for 30 years – and that is okay. However, it is a good idea to contribute at least enough to receive your company’s full matching contribution. This will maximize the benefits of your 401(k) and ensure that you’re taking advantage of the free money offered by your employer.

Roth IRA

A Roth IRA is another common retirement plan. However, it is different from a 401(k) for a few major reasons. First, an individual, not an employer, sets up a Roth IRA. So, I can go to a brokerage’s website, like M1 Finance, and open a Roth IRA without the requirement of employer contribution.

Additionally, a Roth IRA is different from a 401(K) because of how it is funded and taxed. A Roth IRA is funded with after-tax dollars. After-tax dollars are just the earned income that you still have after taxes are taken out of your paycheck.

Think of it as the money that is deposited into your account.

For example, if I get $1,000 deposited into my bank account, that $1,000 is usually what is left over after taxes and other deductions are taken out of my check. So, that $1,000 is considered after-tax dollars and can be put into my Roth IRA.

Now, it might sound like a rip-off initially to contribute some of your paycheck into this retirement account with the little funds you have as a recent graduate or young adult. But there are some benefits to the madness.

Contributing after-tax dollars to a Roth IRA allows your money to grow tax-free and be withdrawn tax-free upon reaching retirement age. This is major because it means that whatever gains you make in your Roth IRA are yours, including the growth and the earnings.

Plus, as a younger person, time is on your side. By contributing to a Roth IRA early in your career, you can take advantage of compounding interest over time, potentially resulting in substantial growth by the time you reach retirement age.

Lastly, unlike 401(k)s, Roth IRAs have much lower contribution limits (check IRS.gov “Roth IRA” for updates) and some income restrictions.

Traditional Investing Account

A traditional investing account is really just a regular brokerage account. There are no special tax advantages or disadvantages associated with a regular traditional investing account. You just buy the stocks, ETFs, or whatever and sell them as you see fit. You will be subject to the regular capital gains tax on any profits you make from selling investments in a traditional investing account.

Health Spending Account

A health spending account is a tax-advantaged account that allows you to save money specifically for medical expenses. To get an HSA, you usually need to be on a high-deductible health plan.

Read More: How to Choose a Health Insurance Plan

A HSA is a great way to save for medical expenses while also reducing your taxable income. Additionally, you can use the money as another way to save for retirement by investing the funds in an HSA and letting them grow over time. This growth, of course, is dependent on you making contributions to the HSA and not using the funds for medical expenses.

So there are two uses for this type of account: saving for current medical expenses or saving for future retirement expenses.

Robo-Advisor vs Traditional Advisor

Robo-advisors are new to investment management. They leverage artificial intelligence and data analysis to provide automated investment advice to investors. These services stand out as a cost-effective alternative to traditional financial advisors and wealth managers due to lower fees and minimum account requirements. Robo-advisor platforms are also leading the charge in improving customer experience and convenience, with user-friendly interfaces and round-the-clock access to data analysis.

Check It Out: I’m using M1 Finance as my budget-friendly investing platform to build a simple, effective retirement portfolio.

Retirement Order of Operations

Alright, we have discussed some of the most prominent terms when it comes to understanding the terminology of retirement saving. Let’s move on to some of the most important steps and considerations in planning for retirement as a young adult.

Let’s talk about the Retirement Order of Operations

The Retirement Order of Operations is a framework that outlines the steps and priorities in planning for retirement.

1) Contribute to the 401 (K) to get at least the full employer match contribution

The first step in the Retirement Order of Operations is to contribute to your employer’s 401(k) or equivalent retirement plan. The most important thing is to ensure that you are contributing enough to take full advantage of any employer-matching contributions. If your employer matches up to 4% of your salary, aim to contribute at least 4% to maximize this benefit. A good rule of thumb when possible is 15% of your income, but contributing enough to get the full employer match is crucial. Eventually, though you want to thrive to max out the contribution limit of your 401(K) or equivalent plan.

2) Max Out Roth IRA

Unlike the 401(k) your goal should be to max out the Roth IRA from the start. The reason is that it has a much smaller contribution limit, so it is more attainable for someone earning a lower salary. Additionally, Roth IRAs offer tax-free growth and tax-free withdrawals in retirement, making them an excellent vehicle for long-term savings.

3) Max Out HSA

If you have access to an HSA it is definitely to your benefit to maximize your contributions. An HSA (Health Savings Account) offers tax advantages and allows you to use the funds to cover healthcare costs in retirement, one of the biggest expenses seniors face.

4) Max 401(K)

Once you have secured your 401(k) employer match and maximized contributions to your Roth IRA and HSA, the next step is to aim to max out your 401(k) or equivalent retirement plan. This is where you can start to supercharge your retirement savings. Of course, you have to be making a high enough salary to max out your 401(k). So, if you are not yet able to max out your 401(k) that’s okay. Just create a plan where you aim to slowly increase your contribution amount.

5) Invest in Traditional Brokerage Accounts

The final step in the Retirement Order of Operations is to put any excess money into traditional brokerage accounts. These accounts do not offer the same tax advantages as retirement accounts, which is why they come last. However, if you still have excess funds, investing in a traditional brokerage account can potentially help you generate more income.

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Best of luck adulting–

And Remember,

Adulting Starts Here!

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