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If you’re a Millennial, you’ve probably been getting flak about everything from your work ethic to smartphone addictions your entire adult life.
But a new retirement study commissioned by Ramsey Solutions shows your generation has a solid start on the future.
- 58% of Millennials are actively saving for retirement.
- 38% already know how much money they’ll need to retire.
- Four in 10 know how old they’ll be when they retire.
In fact, Millennials are doing just as well as—and, in some ways, better than—older generations when it comes to retirement. That’s awesome!
Of course, no generation’s perfect. There’s one important piece of the retirement puzzle that’s missing. The good news is you still have plenty of time to fix it.
Millennials Face a Potential Retirement Pay Gap
Let’s start with the tools Millennials use to build their nest eggs. Here’s how Millennials rank the top three income sources they expect to tap in retirement:
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- Personal savings/cash
- Social Security
It’s no surprise that a 401(k) tops the list. And thankfully, Millennials aren’t banking on Social Security as their main bread and butter in retirement.
But one important retirement tool didn’t even make the top five: the IRA. Worse, cash accounts—which include personal savings accounts, certificates of deposit (CDs) and money market accounts—rank second as future income-generators.
That’s concerning for two reasons:
- Millennials aren’t making the most of their biggest wealth-building asset: time.
- They’re missing out on the opportunity to enjoy tax-advantaged growth on their investments through an IRA or tax-free growth with a Roth IRA.
If things don’t change, Millennials could be facing a big income gap in their golden years. Here’s why.
Cash Accounts Cramp Millennials’ Investing Style
First, let’s break down the dangers of banking on cash to get you through your golden years.
“Cash accounts are great for emergencies or short-term goals, like saving for a car,” Chris Hogan, a financial expert and number-one national best-selling author for Ramsey Solutions, says. “They may be called high-yield accounts, but don’t expect big returns on the money you stockpile there.”
Don’t get us wrong. Cash accounts aren’t bad financial products. After all, they’re FDIC-insured up to $250,000 per person on the account, so you can rest assured in the fact that your money’s safe.
Cash accounts are great for emergencies or short-term goals. But don’t expect big returns on the money you stockpile there.
But there’s a time and place for them in your financial plan. And retirement isn’t one of them. That’s because you’ll be lucky to get a 1% return and you’re losing out on the opportunity to let compound interest multiply your money over the next 30 or 40 years.
Let’s say you’re 25 years old and you make $32,000 a year. You know you should set 15% of your income aside for retirement, so you split your savings down the middle. The first 7.5% goes into your company 401(k), and you throw the rest into a money market account for safekeeping.
After 40 years, you’d be looking at about $1.3 million in your nest egg. Not too shabby . . . but you can do better.
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Invest the entire 15% in mutual funds instead, and your nest egg could be worth more than $2.3 million at retirement. In other words, playing it safe could cost you more than $1 million in lost growth potential!
Roth IRAs Provide the Missing Link
Instead of sticking your money in a savings account that earns next to nothing, here’s a better idea. Invest it in an Roth IRA with good growth stock mutual funds.
“With a Roth IRA, you contribute after-tax dollars, so your money grows tax-free,” Chris Hogan says. “That means Uncle Sam doesn’t get a dime of it when you retire!”
With a Roth IRA, you contribute after-tax dollars, so your money grows tax-free. That means Uncle Sam doesn’t get a dime of it when you retire!
Does it really make a difference? Let’s say you have $1 million saved at retirement. If all of that cash is in a 401(k) and you’re taxed at 25%, Uncle Sam could take a $250,000 bite out of your nest egg. Ouch! That chunk alone could cover healthcare expenses for a couple retiring today, according to Fidelity Investments.
Now, we’re not saying to abandon the 401(k) altogether. If your employer offers a 401(k) match, by all means, take the free money! Just be smart about how you break down your retirement cash. Here’s what we recommend:
- Invest 15% of your gross income. Why 15%? Because it strikes the perfect balance between meeting today’s needs and building tomorrow’s dreams.
- If your company offers a Roth 401(k) option: Consider investing your entire 15% there to take advantage of the tax-free growth.
- If your company doesn’t offer a Roth option: Invest up to your employer match, and put the rest in a Roth IRA. You can contribute up to $5,500 ($6,500 if you’re 50 or older) into a Roth IRA this year. If you max out your Roth IRA and still have money to contribute, go back to your 401(k) to invest the rest.
Of course, this is your future we’re talking about, so don’t make any assumptions. Some 401(k) plans offer great mutual fund choices—others don’t. An investing professional can help you determine whether your company’s fund offerings fit your personal goals. If your current investments don’t measure up, ask your advisor to show you mutual funds with a history of strong returns.
Your Future Is Wide Open
“Millennials have a great chance of reaching their retirement dreams . . . if they take advantage of the time they have to invest,” Chris Hogan says.
So how do you make the most of your time? Partner with a pro who knows the ins and outs of the market and can help you formulate a plan. Don’t settle for someone who pushes you to invest in funds you don’t understand. A good advisor knows you’re in the driver’s seat and gives you the tools you need to make an informed decision about your investments.
With a plan in hand and a dream in sight, you’ll be well on your way to a future you feel good about!