Millennials are overwhelmingly on track for retirement, with about 71% of this generation saving for retirement, according to the Transamerica Center for Retirement Studies. Millennials who have access to a retirement plan at work, such as a 401(k), are socking away 10% of their salaries.
But the term "millennial" covers a wide swath. The Transamerica Center says the generation includes those born between 1979 and 2000. By this definition, the oldest millennials will turn 40 in 2019, which is practically midlife -- a traditional time for thoughts to turn toward retirement.
What about the youngest members of the generation, who are currently between 18 and 24? Turns out, they are not saving for retirement at nearly the rate of older millennials. Only 34% of workers in the 18-to-24 age group said they participate in plans like 401(k)s if they have the option, according to the Pew Charitable Trusts. In the subgroup one notch older, ages 25 to 31, 67% take advantage of workplace retirement plans.
This is a shame, because the youngest workers have time on their side, which helps savers compensate for lower salaries when they're working entry-level jobs early on in their career or working part-time while in college.
An 18-year-old who begins saving $1,000 each year for retirement, for example, and saves the same amount annually until 67, the respective full retirement age (FRA), ends up with $405,579 at retirement, assuming a 7% annual growth rate. But if that 18-year-old doesn't begin retirement saving until 25, the nest egg drops to $246,805 when the saver reaches their FRA.
That's a dramatic illustration of why younger workers can benefit by saving all they can for retirement. Nearly half currently fear they won't be able to meet basic needs in retirement, and a whopping 80% fear that Social Security -- a mainstay for retirees -- will no longer be available for them, according to the Transamerica Center.
In all likelihood, Social Security will remain funded and retirees will receive benefits. But even now, Social Security benefits only supply about 40% of the income Americans had before retirement, on average. Yet folks are estimated to need about 80% of what they were making before retirement to live comfortably. So Social Security benefits alone may cause roughly a 40% shortfall between your retirement earnings and a comfortable life. That has to be made up somewhere, and for most people, it's with retirement savings (or continuing to work).
So what can the youngest workers do? Use the same retirement strategies as their older counterparts, like their siblings and their parents. If your workplace offers 401(k) plans, contribute as much as you possibly can, especially if it's a matching plan, or set up an Individual Retirement Account (IRA) and contribute consistently. Let's take a closer look at these two retirement savings vehicles and the benefits they offer.
The benefits of a 401(k)
About 44% of people between 18 and 24 have access to a defined contribution plan like a 401(k) through their workplace, a figure that has risen steadily. A 401(k) has very specific benefits for retirement savings.
1. Money is automatically taken out of your paycheck, pre-tax, to contribute to your 401(k): Most 401(k) plans require you to choose a percentage of your salary to contribute, from 1% to 6% or higher. That money is automatically taken out of every paycheck pre-tax, so you are not taxed on the amount. It grows tax-free until you withdraw the money at retirement, when it will be taxed as ordinary income. You must take required mandatory distributions, or RMDs, beginning when you're 70.
The evidence is in on automatic retirement savings: Folks save more, more reliably, when it's automated. Why? Because it never hits their pocket, so they can't spend it. It's also more convenient than making a note to contribute at intervals.
2. Your employer might give you free money in your 401(k): One of the biggest draws of a 401(k) plan is an employer match. This means your employer will match a defined amount, usually between 50% to 100% of the amount you're contributing. If your salary is $25,000 and you contribute 2% to your 401(k), you're putting $500 per year away in savings. If you receive a 100% match from your employer, voila: Your 401(k) is funded a total of $1,000 each year.
3. Your employer provides choices in your 401(k): The average employer offers around 13 investment choices for 401(k)s, including index funds and money market accounts. You decide how to invest your money when you determine your contribution percentage.
While many younger investors are shy about the market, the U.S. stock market is by far the most effective way to grow your retirement income. It's the most powerful wealth generator available to you. By investing in stocks, you have a chance at a 7% to 8% annual increase over time, on average. With a money market fund, it's a mere 2% to 4%.
Does the stock market decline? Yes. In fact, in the 50-year period ended 2015, the S&P 500, a measure of the broader market, fell 10% or more in 27 of those years. But each time, those years were followed by years when it rose, recouping those losses and going even higher. Potential downside is a tough fact to come to terms with. But there's no time like the present to accept market volatility if you're between 18 and 24, because you have plenty of time to harness the power of compounding growth.
If you really want to see the comparative effect, remember the 18-year-old who put $1,000 in a retirement fund every year and ended up with $405,579? That assumes an annual 7% increase in a stock fund, about average historically. But the same amount, placed in a 2% money market account, would yield just $83,596 at FRA.
The benefits of an IRA
Individual Retirement Accounts (IRAs) are a different type of retirement savings vehicle, but they offer every benefit of a 401(k) except the employer match potential.
1. Your contributions to a traditional IRA reduces your taxes: Any contributions to a traditional IRA reduces your taxable income for the year in which you contribute. If you make $60,000 and contribute $4,000, for example, you will be taxed only on $56,000 of your income. (Note: you can contribute to a traditional IRA for a tax year until April 15 of the following calendar year. So a contribution made March 10, 2019, for instance, can be deducted on your 2018 tax return.) Traditional IRAs are taxed only when you withdraw them at retirement, so your money grows tax-free as well. You can begin withdrawing money as early as 59 1/2, and you must begin taking RMDs at 70 1/2.
The maximum IRA contribution per year is $6,000 for people under 50. While you can still contribute to a traditional IRA if you are also participating in a 401(k), you can only deduct the full IRA contribution from your taxes if your adjusted gross income is less than $64,000 as a single filer.
You may see the term "Roth IRA" bandied about. Roth IRAs are distinct from traditional IRAs, because Roth contributions are not tax-deductible in the year you make them, but instead the funds from your Roth account are not taxed when you begin to take withdrawals. While Roth IRAs are also a desirable retirement savings type, they don't offer the same immediate tax savings.
2. IRA contributions can be automatic: The institutions that offer IRAs know that people will save more if it happens automatically, so they usually encourage you to set up an automatic contribution plan when you open your IRA.
3. IRAs are self-directed and provide more options: You need to open your own IRA at a bank, brokerage, or other financial institution. They are self-directed, meaning you have a wider array of choices from stocks to funds and bonds.
If you're new to investing, it's a good idea to gather information on the basics, such as the types of asset classes, the difference between them, and asset allocation strategies. Here is a good place to start. Most institutions that offer IRAs will provide primers on these topics as well.