How to Get Started Building Wealth
When you're just starting to earn money, saving may not be the first priority that comes to mind. But it should be.
Competing economic demands and limited income make it particularly difficult for young people to save. After all, you have to pay for a roof over your head, you may need (or want) a car, and you’ll have to pay what may seem like shockingly high amounts for necessities such as food, taxes and health insurance. But starting early is the key to building lasting wealth. And if you have access to a 401(k) plan, building a nest egg may be cheaper than you think.
That’s because many employers match worker contributions at a generous rate—usually between 50 cents and 100 cents on the dollar up to a set limit (commonly 6% of your pay). In addition, contributions are taken out of your check before taxes. Uncle Sam (and states with income taxes) act as if you didn’t earn the money, which lowers your tax bills.
Let’s say you earn $30,000 annually and contribute 6% of your pay to your retirement plan. That works out to $150 per month. Your employer matches your contributions at the rate of 50 cents on the dollar, adding an additional $75 to your account each month. Because your contributions cut your taxable income, you pay $22 less in federal withholding each month and, say, $5 less to your state. In the end, your 401(k) contributions reduce your take-home pay by $123 but your account grows by $225 per month.
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If you keep just this modest contribution rate going until you retire 40 years from now, you’ll have just over $1 million socked away. (This assumes 3% annual salary growth and that you earn 8% a year on your money, or one percentage point per year less than the average annual return of a portfolio made up of 70% stocks and 30% bonds, according to Morningstar.)
So how can you find that extra $123 a month to save? Pack a lunch. Buy a used car rather than a new one (which will also save on auto insurance). Live with Mom and Dad—or add an extra roommate. Pare back your phone, cable, entertainment and clothing expenses. Repay your student loans more slowly by signing up for the government’s Pay As You Earn or income-based repayment plan if you’re eligible. You have numerous ways to squeeze $31 a week out of your budget, and the end result will be well worth the trouble.