Planning for retirement often feels pointless. You’re young and your startup is taking off — why should you worry about retirement now? There are two concepts that make this planning a no-brainer: compounding and tax-advantaged accounts.
- Compounding Interest on interest unlocks exponential growth. If you earn 5% annual interest on a $10k deposit, you’ll have $10.5k after the first year. In the second year, you’ll earn interest on the initial deposit plus interest on the interest you earned. And so on. Over 50 years, a 5% compounded interest rate will grow your $10k deposit to over $110k. The earlier you start, the more time your money has to grow.
- Tax-advantaged accounts The government provides opportunities to invest tax-free in the stock market through retirement accounts. While beating the stock market is hard, maximizing your contribution to tax-advantaged investment accounts provides an instant increase to your future returns.
Compounding, tax-free returns generate long-term wealth. Combining these tools with a broader asset allocation strategy will help you manage uncertainty (e.g., handling a global pandemic) and achieve your financial goals.
Despite the complexity of all the different retirement plan and account types, for most people working in tech, planning for retirement is pretty simple.
Because this is the one-page version, we have made a lot of simplifying assumptions. If your cash comp is $160k+, your company offers 401(k)s with a match, with common choices like traditional and Roth options, what should you do?
- Opt for a traditional 401(k): Deferring taxes until retirement makes sense since you're currently in a high tax bracket.
- Maximize your match: Contribute as much as you can to your 401(k) to take full advantage of your employer match. Ideally, the maximum of your employer match should be the minimum that you set aside for retirement — otherwise, you're leaving money on the table.
- Continue contributing to your 401(k): If you can afford to save even more for retirement, keep contributing to your 401(k) until you hit the $20.5k limit to get the maximum tax deduction. (And at $160k+ of cash comp, you should be able to save $20.5k into your 401(k)).
- Contribute to a backdoor Roth (advanced): Contributing to a traditional IRA doesn't make sense if you've already contributed to a 401(k) since there's no extra tax deduction, so if you can afford to save more than $20.5k, contribute up to $6k to a post-tax Roth IRA via the backdoor Roth procedure.
- Contribute to a mega-backdoor Roth (more advanced): This procedure allows you to contribute up to $37.5k extra to your Roth IRA by making after-tax contributions to your 401(k). It's a complex process and not all 401(k) plans allow it. If you are able to set aside this amount of money for retirement, we recommend that you get a financial advisor to help you through this.