By Hallie Martin

For many of us college students, retirement might seem like a long way off, but the reality is that it’s important to start saving as soon as you can. Just a little bit of money can go a long way with time and interest. Before we get into all the different retirement plans, let’s talk a little about how saving for retirement works. 

So, What’s A Retirement Plan?

With any retirement plan, once you deposit money into the account, it will most likely stay there until you reach the age of 60 (59 ½ to be exact). This means that any money you put into these accounts needs to be funds you can afford to live without until then. In other words, make sure you have enough money to cover all your regular expenses, plus an emergency fund (about 3-6 months of income), before you contribute to your retirement plan. But a retirement account isn’t a simple lockbox for your money; these plans help grow your savings so that you can retire comfortably. 

What Next?

When you open a retirement account, you will be investing your money in securities like stocks, bonds, mutual funds, and exchange traded funds (ETFs). It’s important to diversify your portfolio, which means investing in multiple different stocks and sectors so that if one falls, you don’t lose all of your savings. You should also understand the trade off between risk and return on your assets. Typically, stocks are more volatile (unpredictable and likely to fluctuate) but provide higher average returns than bonds over a long period of time. When choosing your securities, ensure that you have time to recover from potential losses in your portfolio given your mix of assets. 

Now that we have some of the basics out of the way, let’s explore common options for retirement plans. The two main categories are Individual Retirement Accounts (IRAs) and Employer Sponsored Retirement Accounts. You might already be familiar with some of these plans, which include Traditional IRAs, Roth IRAs, and 401(k)s. Below, we will delve into the tax benefits, contribution limits, and decision factors for each account.

Traditional IRA

A Traditional IRA is a retirement plan that allows your money to grow tax-deferred. This means that you are not taxed on any funds while they remain in the account, and you only pay taxes when the funds are withdrawn. Contributions to Traditional IRAs are made with pre-tax dollars, so you may be able to deduct your contribution from your taxable income. The amount of this deduction is dependent on your income, tax-filing status, and workplace plan. The maximum contribution to a Traditional IRA is $6,000 per year for those younger than 50, and withdrawals before the age of 59 ½ will incur a 10% penalty on top of taxes (except for certain qualified expenses). 

Roth IRA

A Roth IRA differs from a Traditional IRA in a few key ways. First, Roth IRAs are funded with post-tax dollars, so contributions are not tax-deductible. Once deposited, savings grow tax-free and distributions, also known as withdrawals, are not taxed when taken out. This makes Roth IRAs beneficial if you believe you will be in a higher marginal tax bracket when you retire than when you are contributing to the account. Like Traditional IRAs, the maximum yearly contribution is $6,000, but Roth IRAs impose further contribution limits based on income and tax-filing status. People filing as single and making less than $124,000 can make the full contribution. You may withdraw amounts less than or equal to your contributions to a Roth IRA at any time tax-free and without penalties. However, any withdrawals of earnings greater than your contributions will incur a 10% penalty and taxes unless you have held the account for 5 years and are either 59 ½ or have a qualified expense. 

401(k)

A 401(k) is an Employer Sponsored Retirement Account that, similar to a Traditional IRA, grows tax-deferred. These plans are provided by an employer, and employees have the option to make contributions through payroll withholding. The maximum contribution limit for persons under the age of 50 is $19,500, with any additional contributions (if allowed by the plan) funded through after-tax dollars. A common benefit of 401(k)s is the employer match program whereby your employer may contribute additional funds to your account. For example, an employer might match 50 cents for every dollar you contribute up to a specified percentage of your salary. Thus, whenever possible, employees should try to contribute enough to get their full employer match to take advantage of these free contributions. As with the other IRA accounts, withdrawals made before 59 ½ will incur a 10% penalty and taxes unless you meet specific eligibility requirements set by the IRS, and at age 72, you must begin taking at least the required minimum distributions. Some employers also offer Roth 401(k)s, which, like Roth IRAs, are funded with post-tax dollars and distributions can be withdrawn tax-free. Be sure to check with your employer to find out what kind of retirement plans they offer, and if you have a work study or on-campus job at UMass, log into Fidelity NetBenefits to check if you are eligible for a UMass-sponsored plan.

How Can SAM Help?

Our role at Smart About Money is to empower students through peer financial education and encourage informed autonomy in personal finance decisions. It is important to note that many Americans live paycheck-to-paycheck and nearly 70% have less than $1,000 in savings, making retirement seem virtually inaccessible. We understand if this is the experience you and/or your family is facing. The hope is that this article catches students early and encourages young people to start investing towards their goals now, if possible. The S&P 500 Index historically provides returns of about 8% annually. At that rate, investing $5 a month from age 20 until 65 could grow your savings to over $26,000. There is power in time and knowledge, and we encourage everyone to use the tools at their disposal to their advantage. If you have any questions, comments, or concerns, please feel free to reach out to me at hnmartin@umass.edu or book an appointment with me or another one of our Peer Financial Coaches on Navigate.