My young daughter is just entering the work-a-day world, but isn’t very money savvy. I want to help her plan for retirement and have considered funding an IRA for her, but I’d like to do more. What’s the best way for me to help her? — Kathy W., California
With more immediate concerns like launching a career, repaying school loans and establishing credit, it’s not surprising that many young adults don’t consider retirement a top priority.
For example, a survey of Millennials earlier this month by the Principal Group found that fewer than a third contribute at least 10% to a 401(k) or a similar plan. Meanwhile, a 2014 State Street study noted that Millennials were holding upwards of 40% of their assets in cash, raising questions about how effectively young people are investing whatever amount they save.
The upshot: While I’m sure plenty of people who are starting their careers are doing a splendid job of preparing for retirement, it’s clear that many others could use some assistance. So, for you as well as other parents looking to help their young adult offspring better prepare for retirement, I have these four recommendations:
1. Introduce them to their older, future self
Research shows that young people are more likely to save when they feel a connection with their older self. Problem is, how to make that connection?
One way is to have your daughter rev up Face Retirement, a fun-but-effective tool that uses age-morphing technology to show your daughter what she may look like at retirement age. To reinforce the notion that you’ve got to put away money today to live comfortably tomorrow, the site also shows the future prices of various items: a gallon of milk might cost $13 and a new car $108,000 in 2051.
I know this tool connects with a younger crowd. After I’ve mentioned it in 401(k) seminars, younger workers invariably run back to their desks and give it a whirl.
2. Put savings on auto-pilot
Of course, no single tool is going to turn anyone into an avid saver. So to give your daughter a sense of just how quickly savings can add up, I suggest you also send her to the Will You Have Enough to Retire? tool, where she can enter different levels of annual income and savings rates and quickly see what size nest egg she might have at retirement.
She’ll quickly see that to have a decent shot at a comfortable retirement, she should be putting away at least 10% and preferably more like 15% in a 401(k) or other company savings plan.
If the company she works for doesn’t have a 401(k), suggest she open an automatic investing plan that transfers money from her checking account to a mutual fund every month. Putting her savings on autopilot rather than requiring her to make a conscious decision to save each month makes it more likely she’ll save rather than spend that dough.
3. Teach them to ignore the Wall Street hype
More than 90% of Millennials say that distrust of markets and lack of investing know-how make them less confident about investing, according to a recent Capital One Sharebuilder survey. Hey, I’d be wary of investing too if every time I turned on the TV some pundit was prognosticating stock market doom or an analyst was contending that you must load up with all manner of arcane investments and reshuffle your lineup every time the Federal Reserve meets.
The truth is that investing doesn’t have to be complicated; in fact, simpler is better. Explain to your daughter that she can create a perfectly acceptable retirement portfolio with just two low-cost index funds — a total U.S. stock market fund and a total U.S. bond market fund. She could even get by nicely with just one fund: a target-date retirement fund, which provides a totally diversified mix of domestic and international stocks and bonds in a single fund.
If she’s still hesitant about investing on her own, she can always check out a robo-adviser, the new breed of investment advisory services that keep costs down by using algorithms to create portfolios.
The main thing, though, is to disabuse her from the notion that she needs to be doing something “sophisticated” or hire a high-cost adviser who claims he’s going to beat the market for her. (Spoiler alert: It’s not going to happen, at least not consistently over a long period of time.)
The sooner she cottons on to the idea that a simple mix of stock and bond index funds that jibes with her tolerance for risk is all she needs to build her retirement nest egg, the less likely she’ll fall into the clutches of the many pseudo-advisers out there peddling the investment equivalent of snake oil.
4. Institute a parental match
I like your idea of funding her IRA. But she’ll get a lot more out of the experience if she has some skin in the game, too.
Assuming she’s eligible to contribute the $5,500 max, tell her that if she’ll come up with $2,750, you’ll spring for $2,750 as well, bringing her to the contribution limit. If $2,750 is too large a nut for her, you can ask her to kick in a smaller sum.
Do this by the April 15th tax-filing deadline, and you can designate the contribution for the 2014 tax year, which means you can repeat the exercise for 2015.
If your daughter qualifies for a Roth IRA, that’s often the better choice for younger people with prospects than a traditional deductible IRA. The idea is that younger investors are better off paying tax on the contribution amount now when they’re in a low tax bracket in return for tax-free withdrawals in the future when they may face a higher tax rate. But don’t get hung up on this.
The important thing is to open the account and get the money saved. Before you do that, however, go to this IRA calculator so you and your daughter know what type of IRA she’s eligible for and how much she can contribute.
One caveat: Don’t assume your daughter will embrace your offer to help with open arms. What the parent may see as a generous gesture, the child may see as meddling. If your daughter isn’t receptive to your plan, don’t push it. It might be better to have a relative or friend she trusts talk with her. Or you might pick up the tab for her to meet with a pro for an hour or two to get her started on a retirement plan.
The important thing is to find the approach that works best for her, and go with that — even if it means you’ve got to watch her progress from the sidelines.
More from RealDealRetirement.com