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Why You Should Save for Retirement with Your First Job
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Fresh out of college and in your first job, it's likely that the last thing you're focused on is retirement. That's understandable—it could be 40 years away, or more! With your first real paycheck, you're more likely to be concerned with making rent and student loan payments than you are with saving for the so-called "golden years."
But the savings decisions you make early in your career can potentially set you up for a financially successful future. The earlier you start saving and investing—regardless of the amount—can potentially make a big difference down the line. Here are some tips to help you get started:
The ABCs of 401(k)s
Only 43 percent of eligible workers under 25 participate in 401(k) plans, compared with 70 percent or more of those over 45.1
If your employer offers a 401(k) plan and will match your contributions, don't leave that "free money" on the table! Because contributions are taken from your pay before your employer withholds income tax, you may be able to reduce your tax bill now, and more of your money will be able to go to work for you.
The power of pre-tax contributions
In this example, an individual who makes $40,000 and contributes $200 per month ($2,400 for the year) may save $360 on taxes now.
  Without 401(k) With 401(k)
Annual salary $40,000 $40,000
Annual 6% pre-tax contribution $0 $2,400 ($200/mo.)
Net salary after contribution $40,000 $37,600
Estimated federal income taxes $4,024 $3,664
Total contribution $0 $2,400
Current tax savings $0 $360
This example is for illustrative purposes only. It assumes a 6% annual contribution (but you can contribute up to the Plan's maximum contribution limit, subject to tax law limitations), and was developed using the Internal Revenue Service's 2014 Tax Rate Schedules. It assumes a filing status of "single," using the standard deduction and one exemption. Your taxes may differ; please see a tax advisor for more information. Taxes are due upon withdrawal from the 401(k) plan. You may also be subject to a 10% additional federal tax if you take a withdrawal from the 401(k) plan prior to age 59½.
There are many advantages to contributing to a 401(k), including:
Pre-tax contributions — You pay no taxes on your 401(k) contributions or any investment earnings until you take a withdrawal. That gives you the benefits of reduced taxable income now and potentially reduced tax payments later in retirement, when you may be in a lower tax bracket.
Post-tax contributions — Your plan may allow you to make post-tax contributions in addition to pre-tax contributions. Although you will have to pay tax on the post-tax contributions, any investment earnings on those contributions are tax-deferred until you take a withdrawal.
Tax-deferred growth — Any investment earnings on your contributions are tax-deferred, giving your account added growth potential.
Matching contributions — Your employer may offer matching contributions—meaning for every $1 you contribute to the plan, they will match a certain percentage of it up to a certain dollar amount. Most people don't walk past money on the ground without picking it up, but that's what people do every day when they don't contribute enough to their 401(k) to get the full company match.
Choice of investments — In a 401(k), you generally have a wide choice of investments, ranging from conservative to aggressive. Many plans today offer target date funds as an option—offered by many plans today.2 These funds are typically made up of a mix of stock and bond funds designed to gradually reduce exposure to risk as the investor gets closer to retirement.
Starting soon can make a big difference
This hypothetical illustration shows how putting money into a 401(k) account at a young age gives it more time to grow and work for you. The result of compounded investment gains can be impressive over a 40-year career.
Contributing Costs you Could grow to
$200/mo. for 30 years (age 35–65) $72,000 $195,851
$200/mo. for 40 years (age 25–65) $96,000 $383,393
This hypothetical illustration assumes contributions are made at the beginning of the month and a 6% annual rate of return. Results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than the original cost. Taxes are due upon withdrawal. If you take a withdrawal prior to age 59½, you may also be subject to a 10% additional federal tax.
Vesting — Even if you leave your job, the vested balance in your account is always yours. You are always 100% vested in your contributions and any earnings on your contributions. The employer match, if any, and any earnings on the match may vest at a scheduled rate determined by the plan. You can rollover your vested balance into a new employer's plan (if available) or into a rollover IRA to potentially keep it growing tax-deferred. You have choices for what to do with your 401(k) or other type of employer sponsored retirement accounts. Depending on your financial circumstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over a 401(k) from a prior employer to a 401(k) at your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment, and provide different protection from creditors and legal judgments. These are complex choices and should be considered with care. You should consult with your tax advisor when making these decisions.
Consider Roth
Not everyone has access to a 401(k). If you don't, as a young investor with a modest income, you may want to consider whether a Roth IRA is suitable for your circumstances. They are different from Traditional IRAs in that contributions are made with after-tax money and aren't deductible—but qualified withdrawals are tax-free in retirement. Being in a lower tax bracket reduces the potential value of the tax deduction you'd get with a Traditional IRA, which is one of the reasons why a Roth IRA might be a better option than a Traditional IRA.
If you're not an experienced investor, the potential tax benefits of a Roth IRA may not be obvious. Say you're 25 and contribute $4,500 each year for 30 years—and earn an average annual return of 6% on your investment—you would have more than $266,000 by age 55! And the money is all yours—you won't have to give the IRS a cent of it if you wait until age 59½ to start withdrawing.
The government sets a limit on who is eligible to contribute to a Roth and how much can be contributed. Contributions must be made prior to each year's tax return deadline for the corresponding year—typically April 15th. But remember, the sooner your money is invested, the sooner potential tax-free earnings can begin to accrue.
Saver's Credit
If your salary is within certain legal limits and you meet certain eligibility criteria, you may be able to take a tax credit for making eligible contributions to an IRA or employer-sponsored retirement plan. The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contribution up to the allowable amount (generally $2,000 to $4,000 for married filing jointly)—with the largest credit going to those with the lowest income.
Next Steps
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1 Source: "Saving Young People From Themselves," The New York Times, April 12, 2014.

2 The target date for these funds is the approximate date when an investor plans to start withdrawing the assets from their retirement account. The principal value of these funds is not guaranteed at any time, including at the target date. These funds are designed to become more conservative over time as the target date approaches.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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