Why Save for Retirement in Your 20s

Why Save for Retirement in Your 20s

Retirement seems so far away while you’re in your 20s that it hardly seems real. In fact, it’s one of the most popular justifications used by people for not making retirement savings. If that fits you, Marguerita Cheng, CFP®, CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland, advises that you consider your deposits as wealth accumulation instead.

Everyone approaching retirement age will tell you that the years fly by and that it is harder to accumulate a sizeable nest fund if you don’t start early. Also, you’ll undoubtedly incur expenses that you don’t now have, like a mortgage and a family.

While you may not make a lot of money in your early years of employment, you do have one advantage over older, wealthier people: time. Retirement savings become a far more enjoyable—and exciting—prospect when time is on your side. Even a tiny amount saved for retirement can have a significant impact on your future, even if you’re still paying off your student debts.

Know Your Goals

It will be better in the long run if you start saving for retirement as soon as possible. But, you might not be able to do it on your own. You might need to seek the assistance of a financial advisor, particularly if you lack the knowledge to successfully traverse the retirement planning process.

When you meet with an advisor or begin developing a plan on your own, be sure to have all the relevant information and to set realistic expectations and goals. During your analysis, you might need to take a few aspects into account:

  • Your age as of today
  • Age at which you anticipate retiring
  • All sources of income, including both your present and future earnings
  • Your present and upcoming costs
  • Amount that you can afford to save for retirement
  • Where and how you intend to reside once you retire
  • Whether you have or intend to have any savings accounts
  • Health coverage later in life is determined by your health history and that of your family.

Compound Interest Is Your Friend

Compound interest is the best reason it pays to start early with retirement planning. If you’re unfamiliar with the term, compound interest is the process by which a sum of money grows exponentially due to interest more or less building upon itself over time.

Let’s start with a simple example to get down the basics: Say you invest $1,000 in a safe long-term bond that earns 3% interest per year. At the end of the first year, your investment will grow by $30—3% of $1,000. You now have $1,030; however, the next year you’ll gain 3% of $1,030, which means your investment will grow by $30.90—a little more, but not much.

Fast forward to the 39th year. Using this handy calculator from the U.S. Securities and Exchange Commission’s website, you can see that your money has grown to around $3,167. Go ahead to the 40th year, and your investment becomes $3,262.04. That’s a one-year difference of $95.

Notice that your money is now growing more than three times as quickly as it did in year one. This is how “the miracle of compounding earnings on earnings works from the first dollar saved to grow future dollars,” says Charlotte A. Dougherty, CFP®, founder of Dougherty & Associates in Cincinnati, Ohio.

If you put the cash into a stock market mutual fund or other growth-oriented assets, the savings will be even more striking.

Saving a Little Early vs. Saving a Lot Later

You might believe that there is still plenty of time to begin saving for retirement. You are still young and have the rest of your life ahead of you, after all. That may be the case, but starting today rather than waiting until tomorrow can save you money.

Use your employer-based retirement plan if you have access to one. You will profit from having an additional boost to your savings because the majority of employers will match some of your payments. Additionally, you won’t even be aware that your money is being saved using pretax deductions.

You can also put money aside outside of your employer. Let’s consider another scenario to drive this idea home. Let’s say you start investing in the market at $100 a month, and you average a positive return of 1% a month or 12% a year, compounded monthly over 40 years. Your friend, who is the same age, doesn’t begin investing until 30 years later, and invests $1,000 a month for 10 years, also averaging 1% a month or 12% a year, compounded monthly.

Who Will Have More Money Saved Up in the End?

Your acquaintance will have amassed about $230,000 in savings. Almost $1.17 million will be in your retirement account. Even if your friend invested more than ten times as much as you did in the end, your portfolio is much larger because to compound interest.

Keep in mind that you’ll need to invest more money each month as you put off retirement planning and saving longer. With your full income at your disposal, it could be simpler to enjoy your 20s, but as you become older, saving money each month will become more difficult. And if you hold off too long, you might even have to put off retiring.

What to Consider When Investing

Your return and, subsequently, the amount available to finance your retirement, will be considerably impacted by the types of assets in which your savings are placed. Because of this, one of the main goals of investment portfolio managers is to build a portfolio that offers the chance to receive the maximum return possible.

Because the main goal is typically to protect capital and maintain a high level of liquidity, money that you have saved for short-term goals is typically held in cash or cash equivalents. Savings for retirement and other long-term objectives are frequently placed in investments with the potential for development.

It’s crucial to be aware that there are additional considerations if you manage your assets rather than hiring a professional or robo-advisor. Below are only a few examples.

Market Risk

Stocks are one example of an investment that has the potential for a high rate of return but also carries a high level of risk. Often, the investments with the lowest rate of return also carry the lowest level of market risk.

Risk Tolerance

When creating your investing portfolio, take into account your capacity for absorbing market losses. Even if it is found that the level of risk is appropriate for your investment profile, it may be practical to rebuild your portfolio to one with less risk if the degree of market risk connected with it causes you undue stress. If it is established that a low degree of risk tolerance has a detrimental influence on your capacity to provide your assets with adequate growth, it may be sensible to ignore it in some circumstances.

In general, one’s level of expertise and financial understanding impact how uncomfortable they feel with risk. So, it is in your best advantage to at the very least educate yourself on the various investment options, their market risks, and past performance. You may set appropriate expectations for your return on investments and lessen the stress that can result if those expectations are not met if you have a fair understanding of how investments operate.

Retirement Horizon

Often, your intended retirement age is taken into account. This is frequently used to calculate how long you have to make up any market losses. It is assumed that since you are in your twenties, investing a sizable portion of your funds in stocks and other comparable assets is appropriate because your investments should have enough time to recover from any market losses.

Individual Retirement Account (IRA)

The amount of income you will have in retirement and how you will be taxed will depend on how you invest for it.

The maximum amount you can deposit or contribute to a standard individual retirement account (IRA) in 2022 ($6,500 in 2023) is $6,000. If you are 50 years of age or older, you may add another $1,000. The annual IRA contribution you make can be deducted from your taxable income when you submit your taxes, which is a benefit. You pay less in taxes as a result. Furthermore, until you withdraw the money in retirement, the money in an IRA grows tax-free.

You must pay any relevant federal and state taxes on any withdrawals of this money. It is intended to be used as an annual addition to retirement income. You would owe a lot of taxes if you removed everything at once.

One other disadvantage of a traditional IRA is something called the required minimum distribution (RMD). If this still exists when you’re 72, you will be required to withdraw a specified sum every year and pay income taxes on it. Previously, the RMD age was 70½, but following the December 2019 passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act, the RMD age is now 72.

Roth IRA

Rather, you might put money into a Roth IRA. When you start a Roth using after-tax money, you don’t get the tax deduction for your contributions; however, when you withdraw the money as a retiree, you owe no taxes on it, and that goes for all the earnings your contributions made over the years. In addition, if you need to before retiring, you can borrow the contributions rather than the earnings.

But, there are income restrictions on who is eligible for a Roth, and those restrictions additionally depend on your tax-filing status (married or single). If you file taxes alone and earn more than $144,000 in 2022 and $153,000 in 2023, you are not eligible to contribute to a Roth.

If your income is below those levels, your contribution might get phased out or get reduced. For the 2022 tax year, the income phase-out range for singles is $129,000 to $144,000. For 2023, the income phase-out range is $138,000 to $153,000.

For married couples who file a joint tax return, the Roth income phase-out range for 2022 is $204,000 to $214,000, and for 2023, it’s $218,000 to $228,000. This means that you can’t contribute to a Roth if your income as a couple exceeds $214,000 in 2022 and $228,000 in 2023. If you’re in your 20s, you’re probably safely below the income limits.

401(k) Retirement Plan

Before you start an IRA, make sure to take advantage of your employer’s 401(k) or Roth 401(k) plan, especially if the business matches your contributions. Many employers will match a portion of your pay, say 3%, as long as you also make contributions to the plan. Pre-tax money is withheld from your paycheck by a 401(k), which is then deposited into a retirement account and invested in a diverse portfolio of stocks and bonds.

There are contribution restrictions for 401(k)s, but you can make contributions to both an IRA and a 401(k) in the same year. For 2022, you are permitted to make annual 401(k) or Roth 401(k) contributions of up to $20,500. (k). For 2023, that amount increases to $22,500.

Financial advisor Carlos Dias Jr., CEO and managing partner of Dias Wealth LLC in Lake Mary, Florida, advises setting your savings on auto-pilot. “Money that is directly placed into your retirement account cannot be used for other purposes and won’t be missed. Also, it aids in your continued financial discipline.

Invest in a Savings Account

You may not get a high rate on a savings account from your neighborhood bank, but you can deposit and withdraw any amount you want, whenever you want. Since each bank has its own policies, some may set a minimum balance requirement or limit the number of withdrawals free of charge. Yet, there are no tax benefits with a savings account, unlike registered retirement funds. In other words, any interest derived from the funds is subject to taxation in the year in which it is derived.

Convenience is another advantage of having a savings account. A savings account can be used for any purpose, including both immediate and long-term demands. A savings account will be useful if you’re saving for a trip, household appliances, a down payment on a car or house, or other things.

Should I Start Saving for My Retirement in My 20s?

Certainly, you should begin retirement savings in your 20s. Retirement may seem far off, but planning for it early helps guarantee you have enough money to support yourself during your golden years. Compounding returns, which will grow your money more over time, are another advantage of investing.

How Much Should I Save for My Retirement in My 20s?

Every person’s answer to the topic of how much to save for retirement in your 20s will be unique and will rely on their work, their spending, and any other commitments they may have. Saving 10% to 15% of your salary is generally a good idea, but even doing so is preferable to not saving anything at all.

You may be starting your work in your 20s, making student loan payments, or learning how to handle your finances. An effective strategy to begin saving is by making a budget. It guarantees that you are saving money and gives you a plan you can follow. You can begin saving in the 401(k) plan offered by your employer, or you can begin investing elsewhere.

What Are the Saving Limits for Retirement Plans?

The yearly contribution cap for 401(k) retirement plans is $20,500 in 2022 and $22,500 in 2023. You can save an additional $6,500 and $7,500 if you’re 50 or older, respectively. The IRA contribution cap for 2022 and 2023 is $6,500 and $6,000, respectively. You can save an additional $1,000 throughout both years if you are 50 or older.

The Bottom Line

It is best to start saving for retirement as soon as possible. Starting early allows you to save less money each month because compound interest works in your favor. The most crucial part of saving for those in their twenties is to simply start.

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