The Total Retirement Planning Checklist for Millennials

While retirement planning for Millennials and Gen Y is expected to be more complicated than it was for earlier generations, there are some basic strategies to follow that can make it easier to boost retirement savings.  Here is your comprehensive checklist to follow to get more traction for your retirement planning.

Like other generations, Millennials are genuinely concerned about their retirement future. Millennials (people who are between the ages of 18 and 34), as well as Gen Y (people born in the 1980s to 1990s and are between ages 18 to 24) also are in an enviable position to prepare for a secure financial future since they have the earnings power now to generate sufficient wealth.

However, unlike other older generations, these two major age groups also have some larger financial burdens to bear, specifically higher debt loads due to college loans and credit card debt, and a lack of wage growth in their jobs.

According to The Project on Student Debt, while Millennials are facing a slowly improving job market, the bad news is that wages have remained relatively stagnant.  To complicate matters, Millennials have major financial burdens to face, such as rising student loan debt and rising rent prices. The Project study also found that college grads from the Class of 2013 have an average debt load of $28,400. This group also values its luxuries, including traveling and dining out at nice restaurants.

But there is also some good news.  Gen Y and Millennials are well-positioned to enhance their retirement plans since they are in, or entering, their peak earning years.

Here are some important tips to consider in your retirement planning:

Take Advantage of Compound Interest

None other than Albert Einstein called compound interest “the greatest mathematical discovery of all time.”   While the math may be complicated, the idea is simple: interest paid out over time is added to your principal contribution and then that interest is added to whatever your total contributions.  Here is an example: a $100,000 deposit that receives 5% simple interest would earn $50,000 in interest over 10 years.  (Simple interest is just an amount of money multiplied by the interest rate over a time period.)  Meanwhile, compound interest of 5% on $10,000 would amount to $62,889.46 over the same period, or a difference of $12,889, or about 25%, over the ten years.

The Benefits of Compounding: The Differences Are Significant Over Time*

*Assumes federal tax rate of 25%, state tax rate of 5% and an annual investment return of 4%.  Source:  www.investor.gov, U.S. Securities and Exchange Commission

The flip side of compound interest is also important.  For Millennials and Gen Y participants who accumulated student loan and credit card debt, compound interest can add just as significantly to your payment balances. It’s best to pay this off as soon as possible.  And while it is very difficult to balance the needs of contributing to a retirement account and paying off student or credit card debt, financial planners agree that reducing one balance while building the other is the safest way to go.

Contribute the Most You Can to a Roth  IRA

As this chart shows, there is probably nothing more dramatic than seeing the combined impact of saving on taxes on retirement contributions, combined with making regular contributions over time, than by looking at how money accumulates in a Roth  IRA. As demonstrated in the chart, investing in a Roth  IRA can make a significant difference in retirement savings. Since there are no tax deductions for contributions to a Roth  IRA, all future earnings are sheltered from taxes. The Roth IRA provides exceptional tax-free growth opportunities.

The Dramatic Benefits of Compounding in a Tax-Free Roth vs. Traditional IRA*

*Assumes single taxpayer, starting with a $0 balance, $5,000 annual Roth contributions made at the start of each year, the pre-retirement tax rate of 20.5; retirement tax rate of 16%%, and an annual investment return of 5%.  Source: http://www.interest.com/savings/calculators/Roth -ira-calculator/

Take Advantage of Funding an IRA

The maximum annual IRA contribution of $5,500 is unchanged for 2015. It is important to note that this is the maximum total contributed to all of your IRA accounts. The contribution limit increases with inflation in $500 increments. An annual change to the contribution limit only occurs if the cumulative effect of inflation since the last adjustment is $500 or more, according to Bankrate.com.

If you are 50 or older you get a break and can make an additional “catch-up” contribution of $1,000. This “catch-up” contribution amount of $1,000 remains unchanged for 2015. To qualify for this contribution, you have to turn 50 by the end of the year in which you are making the contribution.

Beware of High Fees on Mutual Funds and Other Investments

The most important is controlling the fees and expenses of any investment, such as mutual funds.  A recent study by S&P Dow Jones Indices found that 86% of active large-cap fund managers failed to beat their benchmarks in 2014, while almost 89% of those fund managers underperformed their benchmarks over the past five years and 82% did the same over the last decade.

These poor results for active fund management raise the question: Why do investors pay fees to active managers who try, and often fail, to outperform an index fund, when index funds have proven to be much cheaper?

No matter what the investment return to anyone’s portfolio, fees are always being charged.  Thigh fees have a very corrosive effect on any investor’s net return. For example, an investor with a $100,000 401(k) portfolio can pay a 1.5% management fee to an adviser and a 1.4% annual fund expense charge, handing over almost 3% of a portfolio in total expenses annually. Nobel Prize-winning finance professor Burton Malkiel estimated that, over time, fees of just 3% can devour up to 50% of an investor’s returns, as cited in the book, How 401(k) Fees Destroy Wealth and What Investors Can Do To Protect Themselves.

The importance of fees also was illustrated in a May 2015 New York Times article, which cited an audit of New York City pension accounts.  The audit found that over the past 10 years, five pension funds paid out over $2 billion in fees to money managers and “have received virtually nothing in return,” according to New York City Comptroller Scott M. Stringer. The audit covered funds with assets of almost $160 billion. The funds involved cover 715,000 city employees, including teachers, police officers and firefighters.

Maximize Your Retirement Fund Contributions

Maximizing your contributions to any retirement account, such as a 401(k) or Roth  IRA, is one proven strategy to build retirement wealth. This is especially important whether you are a business owner or employee. The combinations of tax benefits, matching contributions, and the power of compound interest over time are both excellent ways to capitalize on a tested method of preparing for retirement.

In 2015, the IRS increased the contribution limit to $18,000 to help reach your retirement savings goals. While the limits on the various tax-deferred retirement accounts are straightforward (as seen in the charts below), there are some exceptions for specific cases.

For instance, if you participate in a retirement plan at work, you can still make contributions to a Roth  IRA or traditional plan. However the IRS says “you might not be able to deduct all of your traditional IRA contributions if you or your spouse participates in another retirement plan at work.” The IRS also said that Roth  IRA contributions may be limited if your income exceeds a certain level.

There also are similar restrictions for persons who may have to pay taxes if they make contributions in excess of the contribution limits, for spousal IRAs, and for making contributions to a retirement account after age 70 ½. See the IRS web site for more specifics.

Consider Investing in Passively-Managed Mutual Funds and ETFs

In a low investment-return environment, investors should recognize that the one variable they can control is fees.  For example, a calculation in Forbes Magazine cited in a Department of Labor paper, showed the impact of high fees on two employees’ investments.  In the example, two employees each contribute the same amount annually into mutual funds. The funds each return 9% annually, but one has an expense ratio of 0.2% while the other has an expense ratio of 1.2%, a difference of 100 basis points, or 1%. At the end of 35 years, the less expensive fund has a balance 23% higher than the other.

Passively managed funds and exchange-traded funds (ETFs) that use indexes can significantly reduce your fees and improve your bottom line return.  You can find out the fees you’re paying for your 401(k) plan and get a projection of how much those fees may eat into your potential returns by logging on to Brightscope,  a site that rates 401(k) plans and offers free reports about fees on about 30,000 plans. You can also research your company’s 401(k) plan yourself by requesting the Summary Plan Description from the human resources department or plan administrator.  The SEC also has information on calculating mutual fund fees.

So, how do you know if your plan’s fees are too high? Christine Benz, director of personal finance for Morningstar, says investors should be on the lookout for 401(k) plans with administrative expenses above 0.5%.

Also, Benz points out that the average expense ratio for actively managed U.S. stock funds is 1.23%. The average expense ratio for stock index funds is 0.72%. And the average expense ratio for stock ETFs is 0.53%

Start a Roth  IRA for a Child

If you have maxed out your contribution limits to your retirement accounts and are in a solid financial position, here is another beneficial choice to consider: Make a gift to a young child by starting a ROTH. In this instance, if your son or granddaughter, for example, earns $1,000 being a lifeguard and would otherwise qualify, she could put $1,000 into a Roth  IRA. Alternately, if she saved half of what she made, you could gift a matching contribution for $500 to allow her to put the full $1,000 into the ROTH. Kids need to earn money if you are going to contribute to an IRA on their behalf. For the 2014 tax year, the limit for a Roth  IRA contribution for those under 50 is the lesser of the worker’s earnings or $5,500.

Consider Buying a House…If You Can

One of the best, time-tested methods of building wealth is by owning real estate.  In this category of asset ownership, the most common is buying a home.  Ownership allows you to build equity, access home equity loans, and over time, to do a reverse mortgage to take out the equity as you approach retirement.  While home prices fluctuate during recessions and are also much localized, home prices have appreciated since around 2000.  Buying a house requires a down payment, as well as money for closing costs, taxes, insurance, moving, and immediate improvements.  Still, it is a better alternative than renting and for building long-term wealth, if it can be done.

When to Retire, Where to Retire?

Most advice on retirement planning for Millennials and the Gen Y age groups focus on the basics of portfolio construction and other financial considerations.  But there is also another important aspect of retirement that only gets marginal coverage.  That aspect is happiness.  Various indexes, such as the World Happiness Report, now exist which measure the “happiest” nations on earth, as measured by factors such as stress, physical health, livability, job, and physical security.  Millennials and Gen Y groups can take advantage of these indexes to break out of the mold to find alternative places to retire outside of the U.S.

While extending retirement past age 65 does earn you greater Social Security benefits, it may require a longer working period than many people planned.  It may also require that you remain in a location that is no longer appealing.  This makes the options of retiring early, moving to a different state or nation more viable than ever. Yes, there are Social Security, federal tax, Medicare, and other health care access considerations, but expanding global internet access, including electronic funds transfers, affords more opportunities than ever to spend your later years elsewhere.

Take Action: 2015 Contribution Limits for Retirement Planning Accounts

Here are the 2015 IRS contribution limits for retirement savings accounts, including contribution limits for Roth , 401(k), 403(b), and most 457 plans.  (A 457 Plan is a non-qualified, deferred compensation arrangement created by state and local governments, tax-exempt governments and tax-exempt employers.) These charts also list the income limits for IRA contribution deductibility.

401(k), 403(b), and most 457 plans

Roth  and Traditional IRA contribution limits

Traditional IRA modified adjusted gross income (MAGI) limit for partial deductibility*

Roth  IRA modified adjusted gross income (MAGI) phase-out ranges*

 * MAGI is an amount used to determine a taxpayer’s IRA eligibility. Generally, it’s the taxpayer’s adjusted gross income calculated without certain deductions and exclusions.

For more information, visit the IRS page on retirement contribution limits.