If I had to rank all the things I love to do in my precious free time, where would opening a retirement account fall? Let me see, hmm… above a root canal, but below politely accepting a religious tract from a door-knocking missionary. (What can I say? Some of them have pretty nice artwork!)
Have you been procrastinating on opening your retirement account? Feeling lazy? Avoidant? Afraid of the paperwork? Feel like you’d rather use that money on stuff you need or want right now? Obviously, I feel you.
But buck up, son! I’m about to tell you why you can’t afford not to open a retirement account.
Wait… what’s a retirement account again?
To recap with a vast simplification: Americans have access to two main kinds of retirement accounts.
First, a 401(k)—or 403(b), if you work for a nonprofit—is a retirement fund facilitated by your employer. You set it up so they can take money directly out of your paycheck and squirrel it safely away for you to use when you’re terrorizing orderlies in the nursing home. That way you can focus on maintaining your record as Wheelchair Drag Race Champion of Shady Hills Retirement Community and not get distracted by petty financial concerns.
Second, there’s IRAs (individual retirement accounts), both traditional and Roth. IRAs are very similar to 401(k)s, but they’re attached to you directly instead of your employer. There are other differences, but meh, they’re pretty minor. You can get acquainted with the finer points later.
Retirement accounts are powerful tools for growing wealth and stability for your future self. The trick is you have to opt into your retirement account. If you’re self-employed, or you work for a company that doesn’t offer 401(k)s, you need to go out and open your own IRA. And if you work for a company that offers 401(k)s, you need to sign up and voluntarily tell someone to NOT give you part of your paycheck every month.
As broke as you are right now, ignoring a perfectly good retirement fund is a terrible idea. Because if you do that, you’ll lose money in three different ways.
Look, I get it: when you need money right the fuck now, it’s hard to even consider saving for your retirement. But you should do it anyway.
Even if you have a mountain of student loan debts right now. Even if you’re trying to save up an emergency fund right now. Just do it, even if it’s only a little bit. Future You will thank Now You. Here’s why.
1. Opening a retirement account unlocks the power of pre-tax income
Your income is taxed by the federal and state government. If this is the first time you’re hearing this, uh, sorry not sorry?
Unless you’re self-employed or a freelancer, these taxes come straight out of your paycheck. That’s a pretty painless way to pay taxes, because it happens automatically. The money never makes it to your bank account. What you get on pay day is only your after-tax income.
Retirement accounts can be traditional or Roth. Either one you choose has the potential to unleash the beast of tax-free income. Here’s how.
If you have a traditional retirement account
If you have a traditional IRA or 401(k), any money you put into it is taken out of your paycheck before taxes. That’s right: you don’t pay income taxes on the money you put in your retirement fund. Tax-free income! That you get to keep! It’s like you’re getting away with tax fraud, but not!
Well, at least not right away. You will eventually pay taxes on it—but not until you take the money out, hopefully many decades from now.
If you leave your 401(k) lying dormant and empty, your paycheck will be a bit bigger, but so will your tax bill. The money you didn’t put in gets taxed just like the rest of your income. And unless you’re this guy, you don’t want to pay more taxes.
If you have a Roth retirement account
Roth account owners choose to pay taxes now. But you’re still able to harness the power of tax-free income!
Under normal circumstances, the government only taxes income once. After that, it shall never be taxed again! (Unless you do something really doofy like withdraw early, but we’re not talking about that today. Tl;dr retirement accounts are like acne. Don’t touch it! Stop staring at it and picking at it!)
But while it’s in your account, it’s growing. With enough time, your dollops of lowercase-m money will coalesce into a massive blob of CAPS LOCK LIKE THE COMMENT SECTION OF FOX NEWS MONEY. And on the day you take that money-blob out and hold it in your arms, neither Uncle Sam nor the Holy Spirt shall ever come between you.
Ready to open an account, but you’re stuck on whether a traditional or Roth is best for you? We have a longer breakdown of traditional versus Roth accounts to help you figure it out. A broad generalization is that Roth is better for young people, and traditional is better for older people? But it really depends on your situation. YMMV.
2. You gain access to FREE MONEY in the form of employer matches
Many workplaces offer what’s called “an employer match.” This means that if you put money into your retirement fund, so will your employer.
Yes, you read that right: all you have to do to get your boss to pay you more is to save for your retirement. You put money in your 401(k), and your company will put more money in on top of that. I shit you not, this is a real thing that can happen to you.
The “match” part of the employer match means that your company agrees to match a certain percentage of your monthly 401k contribution, say 5% or so. This is money that would otherwise be going toward your CEO’s daughter’s Lamborghini fund, but because you are a financially savvy bad-ass, you’re getting it instead. The world doesn’t need another 16-year-old with an overpriced luxury vehicle. But you need dat cash money.
3. You kickstart the wealth-building magic of compound interest
I love the law of compounding interest so damn much. It’s sexy, it treats you right, and it will never break your heart. (Until you borrow money. But we’re not talking about that today. Don’t harsh my mellow!)
Simply defined, compound interest is the interest added to the principal of a deposit. This added interest also earns interest from then on, starting a pattern of slow but exponential growth. Here’s a graph to illustrate this sexy financial concept:
I know, right? I’ll give you a moment to collect yourself.
Collected yet? Great, because you might want to read more on this retirement fund stuff:
- Dafuq Is a Retirement Plan and Why Do You Need One?
- How to Save for Retirement When You Make Less Than $30,000 a Year
- Investing Deathmatch: Traditional IRA vs. Roth IRA
- Do NOT Make This Disastrous Beginner Mistake With Your Retirement Funds
Now picture this: that beautiful, gracefully upward-sweeping blue line diverging from its more rigid green counterpart at increasingly more dramatic intervals is free money that you just get to have if you contribute to your retirement fund. The amount of free money you get will constantly increase over time. All you have to do is keep contributing to your retirement accounts every month. You don’t even have to increase your contribution (though you totally should every time you get a raise). You can just keep tucking away $200 or so of that sweet, tax-free, employer matched cash every single month and the compound interest could eventually double your money.
It’s okay to have other priorities—sorta
You may have a financial goal that’s more urgent. And that’s okay! It may not make sense for you to prioritize your retirement in every season of your life.
Let’s say you have $100 to invest and no debts. A retirement account is kind of a no-brainer.
But if you had that $100 to invest and you had $1,000 of debt on a credit card with a 20% interest rate? That’s different! Go for the debt, for sure. It costs you more to pay the extra interest and fees on the debt.
It’s totally okay to de-prioritize retirement temporarily as part of a comprehensive plan to make your future self happier and more stable. Some people out there make it sound like “if you’re not putting 35% of every paycheck into your retirement you will die friendless and alone, licking moss for sustenance in the mouth of a forgotten cave!” That obviously isn’t true.
I probably should’ve put the phrase “free money” in scare quotes throughout. Because obviously, nothing is ever really free. Especially money.
Still, the three situations we’ve outlined here are as close as the real world will ever come to giving you legitimately free money. And it’s absolutely crucial that you don’t leave any of that money on the table. Max out the company match, then do other things. You’ll thank me later.
So why the hell aren’t you opening a retirement account?
What, you don’t like free money? Does accepting money you didn’t technically earn bother you? Do you want the satisfaction of knowing you had to sweat for every damn dollar you’ll use on puzzles and hemorrhoid cream in your dotage? Do you genuinely think you can afford to pass up on extra free money?
Well get over it, fool. There are very few good reasons not to contribute to your retirement account, and at least a couple hundred thousand reasons why you absolutely should.
So go talk to your HR manager or your boss or company accountant—whoever handles the paperwork for retirement accounts at your place of employment. Don’t know who to talk to? Ask a coworker. Look it up in the employee manual. Whatever. But do it today. Because every day you don’t contribute to your retirement account is a day you’re not accumulating free money. For real.
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A version of this article was originally published on February 1, 2016.