Your child has finally finished college and has started his/her first full-time job. What is the most important financial advice you can give?
Participate in your 401(k) plan as soon as you are eligible. The quality of your child's retirement will largely be determined by the amount of money he/she saves, and a 401(k) plan is a great place for him/her to start. Before marriage, a new home, or other obligations consume his/her entire paycheck, get him/her into the habit of saving. Because the contributions are deducted before he/she even sees his/her paycheck, it's a great way to get him/her into the habit of saving on a regular basis.
Having trouble convincing him/her that this is a good strategy? Perhaps some numbers will make the point. Assume your child starts contributing to his/her 401(k) plan at age 25, contributing $6,000 per year (substantially below the maximum contribution in 2010 of $16,500), with matching employer contributions of $3,000. If he/she earns a hypothetical 8% annually, he/she could have a balance of $2,331,509 at age 65, before the payment of any taxes. What if he/she waits until age 35 to start contributing? At age 65, the balance could be $1,019,549, still a substantial amount, but $1,311,960 lower than if he/she started at age 25. (This example is provided for illustrative purposes only and is not intended to project the performance of a specific investment vehicle.)
What if your child still isn't convinced? Consider reimbursing him/her, as part of your annual gift tax exclusion, for any 401(k) contributions. You can reimburse the entire amount or offer to make a partial reimbursement.
Don't let your child procrastinate because there are too many decisions to be made. Just encourage him/her to start contributing, reassuring him/her that none of the decisions are permanent. He/she can review contribution levels, investment choices, beneficiary designations, and other matters at a later date.
If your child has the option to contribute to a regular 401(k) plan or a Roth 401(k) plan, suggest contributing to the Roth 401(k). Employer matching contributions will still be made to a regular 401(k) plan, but your child's contributions can go to the Roth 401(k). Your child won't get a current tax break for contributions made, but he/she will owe no taxes on the contributions or any earnings when withdrawals are made.
What if your child doesn't have a 401(k) plan at work? Encourage him/her to contribute to an individual retirement account (IRA). Although contributions are limited to $5,000 in 2010 compared to $16,500 for 401(k) plans, IRAs are still a good way to save for retirement.