By NEALE S. GODFREY Special to the Daily Press
It might seem a little strange to talk to your kids about retirement, but when you consider the pickle many adults are in when it comes to this issue, planning early doesn’t sound so crazy.
If someone had talked to us about saving for the future when we were young, things might be different. So don’t be afraid to share this important message with your youngsters. With employers eliminating pension plans and Social Security under-funded, the only things your kids will be able to rely on is time and the miracle of compounding interest.
Here’s some food for thought: Suppose your kids set aside $20 a week, or about $1,000 a year, in a mutual fund that generated 10 percent interest, just from the time they were 15 until they turned 24. If they stopped investing after 10 years, never adding another penny, at the age of 55 they would have $336,500 — a 3,265 percent return.
The main reason it’s important to start saving while you’re young is that if you don’t, you’ll never catch up. Let’s say your kids don’t start saving for retirement until they get their first real job at 25 years old. Instead of saving for only 10 years, they save $1,000 a year for 31 years, setting aside a total of $31,000. They should do better, right? Wrong. By 55, assuming the same 10 percent compounding rate, they will have just $200,140 — a 552 percent return. The point? Teach your kids the joys of saving now, no matter how old they are.
You don’t have to explain the concept of retirement to your 10-year-old, just help him or her develop the habit of saving. But if your 25-year-old hasn’t started saving for retirement, it’s time for a serious conversation.
There is no magic number of dollars they should set aside. The income they’ll need in retirement will depend on their lifestyle and how long they’ll live. Retirement experts recommend you plan to replace at least 80 percent of your pre-retirement income.
Today, retirement income can be described as having three prongs: pensions, Social Security and investment income. The one we have the most control over, and the best place to focus your child, is investing.
But first, let me highlight a conversation you can have with recent college grads who are getting their first job. If their employer offers a retirement plan, advise them to sign up as soon as possible. The small reduction in take-home pay is worth the long-term security. Young adult workers should find out what types of plans are available, when they can sign up and whether the employer makes a matching contribution — which is essentially free money. It’s shocking how many new hires don’t contribute to their company plan because they see it as a reduction in their paycheck.
Explain to your young adult that if it’s available, a tax-deferred employer-sponsored plan can be a great vehicle for retirement savings. The fact that it’s tax-deferred means neither the amount added by the participant nor the interest earned will be taxed until the money is withdrawn — which, hopefully, won’t be until your baby is old and gray. Remember, they may be upset that their take-home pay will be reduced. Help them understand that the money is not being “taken away” from them, but merely being set aside for the future. Also, since it’s being put in a tax-deferred account, they will be paying less in taxes each pay period.
There are rules on these plans. There will be a limit on the amount they can invest each year. The money is generally not available until the participant is 59 1/2 without having to pay a 10 percent penalty and the applicable taxes. Dipping in early will cost them.
What you need to stress to your kids now, whatever age they are, is the value of long-term investing. There will not be any limits or restrictions on the amounts they can invest or withdraw outside their tax-exempt accounts.
If they do invest in regular taxable investments, the good news is that they’ve already paid taxes on the money they’ve invested and they’ll pay taxes every year on most of their earnings from that investment. So when they do withdraw the money, there won’t be a big tax bite taken from it.
Too soon, you say, to discuss with your kids? Well, for the little ones it may be a bit early for all this tax talk.But it’s never too soon to discuss the habit of saving for the future. (Financial expert Neale S. Godfrey has written 14 books, including “Money Doesn’t Grow On Trees” and “Money Still Doesn’t Grow On Trees: A Parent’s Guide To Raising Financially Responsible Teens and Young Adults.” Her special program, “Your Money, Your Children, Your Life,” has aired on public television stations. See her Web site www.childrensfinancialnet-work.com.)
Originally published in the Santa Monica Daily Press print edition on September 7, 2006. Read the original PDF.