How should a 25 year old couple begin saving for retirement?[ Edited ]
Hello, I'm just looking for advice on retirement options. Here are the facts: I am 25, married, wife doesn't work (but receives medical pay), I am active duty military, E-5 (plan on doing 20 years), haven't started saving for retirement, and I have not put money into TSP. That being said I have just re-enlisted and have set aside $10k that i want to start a retirement fund of some sort with. I plan on making monthly contributions as well as this initial lump sum. Debt wise, i owe on my car, credit cards are paid off, wife has no debt, and I have a mortgage on my house. I have extra money left over every month after bills are paid. I have been reading about compound interest, IRA's, stocks, bonds, etc... All in all these are a bunch of words to me that I somewhat understand but by no means an expert. If you could point me in the right direction on getting started and making the most money with moderate risk I would be very grateful. Thank you.
Thank you for your question and for your service to our country. And nice work on your financial situation thus far! It looks like you and your wife are off to a great start.
Account Type First, Then Investments
So the first thing I think you should do is to decide on your approach to retirement saving. In other words, do you want to use the TSP (it’s easy and has low cost funds), an IRA(s) (they offer greater investment flexibility), or do you want to use a currently taxable investment account (so that you can use the money for purposes other than retirement without incurring tax penalties)?
When it comes to this decision, I typically prefer to see people use their employer-provided plan (the TSP in your case) or an IRA as their primary approach rather than a taxable account. Why? Because these plans offer potentially greater tax benefits plus the penalties for using them for purposes other than retirement are a nice deterrent that will hopefully cause you to not touch the money for anything else. Note that for your lump sum, the TSP is not an option since it has to be funded with payroll deductions.
Pre-tax or Roth?
Assuming you’re with me on this line of thinking, you’ll then have to decide if you want to use the traditional, pre-tax version of these plans or the Roth version.
- Pre-tax. With a pre-tax plan, the money you set aside reduces your income for the year, consequently lowering your tax bill. If you use the traditional TSP, this happens with each paycheck. The money is contributed (and your taxable income reduced) before you ever see it. With a traditional IRA, you have to contribute it yourself and then account for it when you file your taxes. Assuming you’re eligible to deduct your contribution (which depends on total income for your tax filing status), the reduction of your taxable income is done on your tax return. With either of these plans, the taxes on any growth you experience each year are deferred until you pull the money out in retirement. At that time, it’s 100% taxable. To avoid additional penalties for early withdrawal, you typically have to wait until age 59 ½.
- Roth. With a Roth plan, you get no upfront tax breaks for the money you contribute – either to the Roth TSP or a Roth IRA – but, like the pre-tax plans, the taxes on any growth you receive each year are also deferred. Different than pre-tax plans though, money pulled from Roth accounts in retirement is generally 100% tax-free assuming you clear a couple IRS hurdles.
As for how to decide which plan to pick, pre-tax or Roth, it really depends on your best guess about your tax rates now versus your tax rates in retirement. Generally, if you think you’ll be in a lower tax bracket in retirement than you are when you make the contributions, the pre-tax plan will be the way to go. On the other hand, if you think you’ll be in the same tax bracket or higher in retirement, the Roth should win. In truth, once you have the funds to support it, using all three of these account types (pre-tax, Roth, and currently taxable) can be a good idea since it’s impossible to predict future tax rates.
Having said that, once you’ve decided on your account type, you’ll then have to decide how to invest the money you contribute to it. Since the dollar amount you’re starting out with really isn’t large enough to effectively use individual stocks or bonds (and they’re not available inside the TSP if you go that way), mutual funds will probably be your best route. Ultimately, you’ll want to invest in a diversified manner that is in line with your tolerance for risk. To do this, you can either select a single mutual fund that provides diversification by investing in multiple funds inside of it, or you can build your own diversified portfolio of funds by allocating your contributions across several asset classes. This can get a little complicated for a beginning investor so I highly encourage you to contact our team of Financial Advisors here at USAA to discuss how to do this. They can be reached at 800-771-9960.
One final note
Finally, while I think it’s great to start saving for retirement in your mid-twenties, before you go too far down that path, make sure you’ve got a good solid emergency fund in place first. Ideally we like to see people set aside 3-6 months’ worth of their committed expenses but it’s completely acceptable to start smaller. You should have at least $1,000 set aside and perhaps even more just to make sure life’s negative financial surprises (which do happen) don’t derail your plans.
Thanks again for your question. I hope this helps and I wish you and you wife all the best!