Set yourself up for early retirement … or whatever

While this post is in part directed toward someone that I genuinely care about, I hope that it can help the hundreds/thousands of youth as they try to roll along their merry way in their working careers. I can be used to help you set yourself up for early retirement, or to choose to begin a new career if you so choose.

I want to admit that I wish I had this advice impressed upon me when I was a young person. If I had this knowledge (or better understanding of one purpose my math classes) in my youth, I would literally be a millionaire today. So if you want to begin your financial life on firm ground, you should seriously consider using what I suggest below.

Once you get a job that pays you money, you should put at least $5,000/year away for your future. How do you do this? Well, $5,000/year is $416.67/month … whoa, I can’t put that much away … or can I? That is also $20/day that you’re working … does that still sound difficult? Okay, hear me out.
Before you started earning minimum wage (currently $7.25/hour), you were making how much? … Yep $0/hour or $0/day or $0/month or $0/year (well unless mom/dad/aunts/uncles were paying you to do odd jobs), either way you were earning nothing.
So now you’re making $58/day if you make minimum wage. Obviously if you’re making $80/day (or $10/hour or $20,000/year), you will have that much extra.
It is of course much easier to put away when you have more money, which is common sense. However, don’t overlook the choice you have of putting away most of your money before your monthly obligations become too large, such as rent/mortgage, cable/satellite bill, cell/phone bill, car & car insurance & gas & oil changes & tires & brakes, etc.

Note that when I talk about “Traditional IRA” you can replace that with “Traditional 401K”, and when I refer to “Roth IRA” you can replace that with “Roth 401K”. The basic differences between a 401k and an IRA are how much you can put into it in any year. IRA currently (in 2013) has a maximum contribution limit of $5,500, while a 401K has a maximum contribution amount of $17,500 (in 2013). Those amounts are also increase if you are over 50.

Now using the compound calculator view of the Finance101 calculator available for free, you’ll see that if you put away $5,000/year toward retirement, you only need to do that for the first 5-8 years of your working career, depending upon when you start working. At age 17, you’d only have to put away that amount for 5 years ($25,000). If you wait until you are 22 years old then you have to put away that amount for 8 years ($35,000).
Does it hurt a little bit? Heck yeah. After all, if you’re making $14,500/year (minimum wage), $5,000 is almost 34.5% of your paycheck! If you’re lucky enough to make $20,000/year, it is 25% of your paycheck.

So how does that help me anyway?

Well, let’s say you were only making $14,500/year and put away $5,000 that first year. When you’re making $20,000/year you’ll see that you just got 9.5% more ($1,377.50) every year to spend as you want to. Go on a vacation to Aruba for a week if you want!

Won’t that money (i.e. $1,377.50) be taxed?

Short answer: Yes (for Roth IRA), or No (for Traditional IRA).
Longer answer for Roth IRA is: Any money earned by a person who is single will be taxed at 10% for Federal taxes (in 2013 at least) up until they earn $18,450, and 0%-7% for state taxes.
10% of tax on $1,377.50 above would be $137.75. So if you live in a state that you don’t have to pay income taxes in, the take home pay will be about $1,239.75, in 2013 anyway. And I say about $1,239.75 because if your income is $20,000, then the last $1,550 is taxed at 15%, which means you’ll have to pay an additional $232.50 bringing your additional take home pay down to $1,007.25. The benefit here is that if the account grows as you would like, you can take ALL of the money out when you are age 59 1/2 or older (and for a couple other reasons), without paying taxes on it at all! If it’s $1M in the account and you’re withdrawing $40,000/year (which is 4%) when you are 59 1/2 or older, you will not have to pay any taxes on it!
Longer answer for Traditional IRA is: Any money earned by a person who is single will NOT be taxed for Federal taxes (in 2013 at least) up until they earn $18,450, and each state tax varies the rules on their income taxes. The $5,000 contribution into your Traditional IRA is tax deductible and so your income taxes would be lower than if you put the money into a Roth IRA. The caveat to this is that when you take the money out, you will be taxed at the rate once you remove some or all of the money from the account when you decide to retire. Taking 4%/year out of a $1M account is $40,000/year, which you will have to pay taxes on!

That’s a LOT of numbers, what is the shorter version?

If you make $20,000/year for at least 6 years (which is $120,000 BTW!), and put away just $30,000 of that money (which is only 25% or 1/4 of what you earned), and earned 8.4% in the investment so that it compounds until you are 65 years old, you’ll have over $1,000,000!

45 years is a long time to wait, can I take it sooner?

Yes. If it is a Roth IRA, you can take up to the amount you initially deposited (our example would be $30,000) ANYTIME you want to. It just will not be able to compound as much. If it is a Traditional IRA you have to wait until you are 59 1/2 years old or other special circumstances, which are beyond the scope of this post.

Can I continue you do this for more than 5-8 years?

Yes. Currently you can do this for your entire working career. If you decide to put in $5,000/year from age 22 thru age 45, you certainly can do that. You’ll just have $1,900,000+ by the time you’re 65 years old! Or if you decide to take some time off from work at the age of 45, you will have $120,000 that you can take out of a Roth IRA, or $0 out of a Traditional IRA (unless you have a specific “hardship” situation in your life). If you want to put away more in an Traditional/Roth IRA, you could put $5,500/year away as of 2013. If you did that from ages 22 to 45, by the time you’re 56 years old you’ll have an account worth over $1,000,000. If you decide to do it until you’re at full retirement age (age 67 for anybody born after 1938 according to the SSA website)

Why not just wait until I make more than $15,000 a year?

Well simply because compounding takes time. The longer you leave the money sit there and don’t touch it and it is growing, the better off you will be. If you never make more than $15,000/year, than you would only need $250,000 saved up to pay yourself enough money for the remainder of your life, which would be at the age of 36 if you started saving $5,000/year when you were 17 years old. Why is that? Well using the Finance101 calculator view, you only have to put in $10,000 for the amount that you need, and then click on the Yearly radio button. Why $10,000 and not $15,000, simply because you were living off of only $10,000 before you started drawing on your retirement accounts.

Now to go the extreme case, let’s say you’re able to make $15,000 after taxes and put it all into the account. How many years do you have to deposit that much in contributions until you can just live with withdrawing $15,000/year out of your account for a very long time. If you were withdrawing $15,000/year and you weren’t withdrawing more than 5% of your investment money, you would need only $300,000 saved up, which would only take 11 years. If you started putting that much into an investment account every year starting at age 17 for 11 years and earned 8.4%/year in the investments, you would be 28 years old and able to pull $15,000/year out of those investments if they were in a regular brokerage account!

PS: If you haven’t figured it out yet, just mouse over any of the numbers that have a lightgray background to see how the calculation is done.

This entry was posted in 401k, budget, budgeting, financial directive, Growth, IRA, Retirement Savings, Roth IRA, spending plan and tagged , , , , , , . Bookmark the permalink.

5 Responses to Set yourself up for early retirement … or whatever

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