Surviving on $40,000 a Year While Saving for Retirement
If you're like me when you started working your first job you were not making nearly as much as you felt like you deserved. Could be my millennial entitlement or could be that real wages have barely budged in the last 40 years. With Trump claiming the economy is the best its ever been you would think American would be making more than their parents did at the same age but sadly were not. 2019 had the highest annual increase in average hourly earnings since 2009 at 2.8%. This would be great if the consumer price index had not risen 2.7% giving us a real wage increase of just .01% in the "greatest [economy] ever" according to Donald Trump. However that’s for another article. Like the title says this article is going to be about how to survive on $40,000 a year while saving to be a millionaire in retirement.
The Power of Compounding
If you are fortunate enough to have an employee sponsored 401k plan that matches part of your contribution. That is 100% of the time where you start your savings. Your employer is basically giving a bonus to employees who are responsible with their money. When starting a job make sure you ask about the company's retirement plan. Typical 401(k) plans are tax deferred which means you do not pay taxes on your contributions until you withdraw the money in retirement. This allows for something called triple compounding. Triple compounding is when your principle is gaining interest, your interest is gaining interest and the money you normally would have paid to taxes is gaining interest.
If you contributed the maximum allowed in 2019 of $18,500 for the next 40 years and assumed a very reasonable interest rate of 5% you would have $2,799,670. If your employer matches up to 5% of your salary and we assumed you never made more than $40k a year you would have over $3.1m. Now you may not be able to contribute $18,500 of your $40,000 when you are first out of school and that’s fine but as soon as it makes sense for you to do this, your future self will thank you.
Let's Pay Some Taxes
Now if you are in your first job and your employer does not match your contribution, investing in a tax deferred retirement plan may not make sense for you at this time. Make sure you know your tax bracket.
If this is your first job and you are reading this you likely care about you finances and believe that you will be making more money in the future. The 22% tax bracket will likely be the lowest tax bracket you are in for the rest of your life. This mean contributing to a tax deferred retirement plan may not make sense. Lucky for you there is a retirement plan that is made for this situation. It is called a roth IRA and it allows you to contribute after tax dollars into this plan and you will never pay taxes on it again. Every dollar that is made in this fund will go tax free forever. There are limits to your contributes, however. In 2019 the max you can contribute is $6000 and you should absolutely max this out.
1. If your employer matches contribute as much as you can to their 401(k). If possible do the maximum $18,500. Then if you have money left over contrubute to a Roth IRA.
2. If your employer does not match but does offer a retirment plan. Max out your Roth IRA ($6000) then contribute to your employers 401(k) plan with as much as you can afford.
What will make the $18,500 and the $6,000 so difficult for a lot of you is your student loans. Paying off your student loans should be your number one priority when working your first job. It should be ahead of retirement planning, ahead of going on trips, ahead of buying a car. Any loans over 7% pay them off now. Put half your paycheck towards them, pick up a weekend job and put that entire paycheck towards them. The faster you pay these off the quicker you will become a millionaire. Anything in the 3-5% range just make sure you are on a healthy payment schedule of around $500 a month.
How do I get a Roth IRA Account?
If you know nothing about investing and do not want to be burdened with researching stocks and making sure you have a properly diversified portfolio than Vanguard is the right place for you to open you Roth IRA.
It's super easy and can be fully set up and funded in 15 minutes without leaving your house. In my article titled How to Create a Diverse Retirement Fund I will explain how to set up an account and what simple options you have for creating a diversified fund for your risk tolerance and needs.