Under 25? Start Your Retirement Planning Today
By starting now, you might be setting yourself up for a beautiful future.
Getting started in your 20s
- Retirement will be here sooner than you think
- The sooner you start saving, the more money you could potentially have
- Having a financial cushion is essential
Welcome to your 20s! Maybe you’ve graduated from college, or you’ve left home and are living on your own for the first time in your own home or apartment.
It’s a time of exciting adventures, meeting new people who will be important to you for the rest of your life, and discovering who you are in the world.
While you may not have everything figured out, you’ve probably started your first (or second) job and are mapping your career path. It may be tempting to live large—purchasing cars, nice clothing, vacations, or fancy meals out, but it’s also important to start saving.
Although that may not seem as exciting as traveling to distant lands, think of all the wonderful things you’ll want later in life—your own home, a nest egg for when you have time to write your book or take up the drums. We all need cash to afford our future dreams.
It’s also critical that you start putting money away, both by saving and investing for emergencies. Life throws everyone curveballs, and you can never be sure what will happen. Having a financial cushion is essential.
Why think about retirement now?
It may seem crazy to start thinking about retirement when you’ve just gotten started with your new job. But really, it’s not.
The sooner you start thinking about saving and investing, the better. Waiting even a few years can dramatically reduce your retirement savings. The following chart shows the difference in your potential nest egg if you start at 25 compared to 35. The person who waits ten years might have almost half as much money in retirement.
And you shouldn’t worry about timing the market, which means making guesses about when to buy and sell stocks and other securities based on how the market is doing. By investing small amounts of money consistently, typically on a weekly or monthly basis and over a period of years, you’re likely to see a positive return on your money, although investing always includes risk.
The big picture
It’s also important to realize that while retirement may seem like it’s a long way off, the time when you stop working will be here sooner than you realize.
And unlike our parents, many of whom had pensions or other investment programs that they contributed to over the course of their careers, you’re likely to have to fund your own retirement.
By some estimates, only 10% of us will have pensions, and it’s likely we’ll have less money from Social Security than previous generations. People are also living longer, into their 80s, 90s, even 100s.
There’s also uncertainty about what health care will look like in the future, but it’s likely to be a big expense that will require additional retirement planning.
The big picture, facing reality
- Getting your financial life in order can be challenging
- The median salary for people in their 20s and early 30s is between $29,000 and $38,000
- The average student loan debt is about $14,800
We get it. Getting your financial life in order can be hard, especially when you’re young.
Fact: The median salary for people in their 20s and early 30s is between $29,000 and $38,000, according to federal government data.
Putting money aside that you don’t touch for decades may seem like an impossible challenge, especially if your monthly living expenses are high, and if you’re living from paycheck to paycheck.
Maybe you’re saddled with medical bills, credit card or student loan debt. In fact, if you’re like most people in their 20s and just out of school, the average student loan debt is about $14,800 per household, according to recent data.
The world is yours (but it might be a little crazy)
It may also not always be possible to save the same amount of money year after year. You might be laid off, or change jobs, or move to another city. Of all the generations, people in their 20s now are more likely to change jobs than any other.
That can make it hard to have a continuous stream of income, and it can complicate plans to put money away regularly.
The sooner you get a plan together to save and invest, the sooner you can get on track to have the kind of retirement you want.
Making a budget
- Experts recommend putting away 10% to 15% of your income annually for retirement
- Nearly three-quarters of American have less than $1,000 saved
- Consider a budget that follows the 50-20-30 rule
Saving and investing should be a lifelong process.
And financial planners generally recommend putting away 10% to 15% of your income annually in order to have a healthy retirement fund.
Some experts even recommend putting away up to 25% of your income, if you can, because it could help get you to your savings and investing goal more dependable. But don’t worry so much about the number. If you can only manage 10% or 15%, that’s amazing. You’re still saving and saving regularly, which can put you far ahead of the game.
Regardless, it’s important to start young. Nearly three-quarters of Americans have less than $1,000 in savings. One third have no savings at all, according to reports.
It’s also critical to start now because as you get older, life is likely to get more expensive. While your income is also likely to go up, you’ll likely also have a more expensive lifestyle to maintain, including houses, cars, children, and everything else life throws at you.
One of the best ways to get control of your financial life is to create a budget.
What’s a budget?
A budget is a game plan for your money. It provides a bird’s-eye view of your finances and allows you to plan for your daily, weekly, or monthly spending. A budget is a building block that will help you figure out how much you can save and invest each month, and every year.
A budget helps you determine if you have enough money to cover your bills, and how much you have left over to save or invest for the future. The most typical budget follows something called the 50-20-30 rule.
This says that you should put 50% of your take-home pay toward your fixed living expenses–the expenses that you’re obligated to pay each month—such as your rent, mortgage, or student loans. You should save or invest 20% of your income, and use 30% for flexible expenses, which change over time and that you can control, such as groceries and entertainment.
Strategies for saving
- You should aim to save between three and six months of living expenses
- If you have debts, it’s important to start paying those off
- Once your debts are paid off, it may surprise you how much easier it is to save
Once you have a budget and know how much you can save each month, you should consider saving for emergencies. The general rule of thumb is to amass between three and six months worth of living expenses, in a cash account that’s easy to access.
That way if you’re laid off or change jobs, or move to another city, you won’t be running yourself into debt, or asking your parents for money to help you out.
If you have debts, you should start paying those off. Start with your high-interest debts, such as credit cards. See if you qualify for a 0% introductory rate, and think about transferring balances that you know you can pay off before the teaser rate expires.
After that, you can tackle your student loans. These may seem insurmountable, but you have to come up with a plan for paying them off. They weren’t meant to haunt you your entire life. In fact, most people tend to pay them off within ten years, and federal educational loans aren’t meant to last longer than that.
Once your debts are paid off, you’ll be surprised how much easier it is to save money.
Let's talk retirement
- Once you have an emergency fund saved, you can consider investing
- Investing is potentially a powerful way to build wealth
- By investing, you can learn to take advantage of the power of compounding
Once you have your emergency funds socked away in a savings account, you can consider investing.
Investing is potentially a powerful way to build wealth, by owning stocks, bonds, funds and other market securities that have the potential to become more valuable over time.
Here’s the thing about keeping your money in a savings account: while it’s generally safe to keep your cash in a bank account, it probably won’t earn you much money by just keeping it there. In fact, on average, the interest on a savings account won’t keep track with inflation, which can wear away at the value of your money.
By investing, you can learn to take advantage of the power of compounding. Compounding is when the interest your money earns also earns interest, magnifying your savings.
This chart will show you how compounding works, assuming you put aside $50 a week, or $200 a month for the next 30 years, earning 5% annually. You’d have $159,669. With interest and compounding, that’s more than double the $72,050 of principal you put away.
If your workplace has a 401(k) option, you might want to put money in that, particularly if your job offers you matching money. A 401(k) is a type of employer-sponsored retirement account that many Americans have through their jobs. Matching money is cash that an employer will give you, usually up to a certain percentage of your own contributions, meant as an incentive for you to stay at the company.
If you don’t have access to a 401(k), don’t worry. You can still set up your own retirement account. It’s called an Individual retirement account, or IRA.
There are two types of IRA. Let’s start with the traditional IRA.
What’s a traditional IRA?
It’s funded with your pre-tax dollars, so the money you contribute to your traditional IRA can lower your annual tax bill.
As we said earlier, there are annual limits to what you can contribute. You can put up to $5,500 away each year. Once you’re age 50 or older, you can contribute up to $6,500 annually.
After age 59 ½, you can take money from the account with no penalties. By age 70 1/2 you’re actually required by the IRS to start taking money out of your account. This is called a required minimum distribution (RMD).
An RMD is an amount you must withdraw from your traditional IRA starting at age 70 ½. The amount is determined by an IRS formula that comprises life expectancy and account value.
The other type of IRA is a Roth IRA. You fund a Roth with the money you’ve already paid taxes on (called your net income). Once you’ve funded the account, your earnings can grow tax-free.
Roth IRAs also have yearly contribution limits, meaning you can only put in $5,500. However, like a traditional IRA, if you’re 50 or older, you can contribute up to $6,500.
When you’re age 59 ½, you can access this money without paying a penalty. Unlike a traditional IRA where you are required to begin taking money out of your account by age 70 ½, you can keep adding to your Roth IRA for as long as you like.
(There are limits based on income, and tax filing status, which you can read more about here.)
This chart will help summarize some of the differences:
|Traditional IRA||Roth IRA|
|Tax benefits||Funded with pre-tax dollars; taxed after retirement||Funded with money you've already paid taxes on; earnings grow tax free|
|Annual contribution limit||$5,500 ($6,500 if you're 50 or older)||$5,500 ($6,500 if you're 50 or older)|
|Withdraw without penalty||At age 59 1/2||At age 59 1/2|
|Required minimum distribution||By age 70 1/2||Never|
Pat yourself on the back for starting to save and invest in your 20s. If you can learn to put even small amounts of money away every week and every month, you may be well on your way to the retirement you want to have.
Retirement may seem like it’s years away, but it really is just around the corner. If you can start now, maybe by putting 5% of your income away, and increasing your contributions to a retirement account later on as you earn more money, you’ll be on the path to having the retirement you want.
Which of the following presents a financial challenge to people in their 20s?
All of the above. The average 20-something faces numerous challenges to their financial lives, including a relatively low salary, frequent job changes, and student loan debt. On the bright side, if 20-somethings manage to start saving, they also have more time to harness the power of compounding!
It is beneficial to start saving for retirement sooner rather than later because...
The longer you save, the more money you’re likely to have. Time is your best friend when it comes to long-term saving. If you start putting money toward your retirement account in your 20s, and you contribute more as you get older and earn more, you could have a lot more money available to you when you need it. If you’re older, you may have to put more money away now to catch up, but the sooner you start, the better.
Your money "compounds" when it...
Earns interest on the original amount, as well as the interest earned. Compounding is when the interest your money earns also earns interest, magnifying your savings. When you invest, you can take advantage of the power of compounding. The earlier you start—in your 20s, for instance—the more time your money will have to earn compound interest!
A traditional IRA...
All of the above. A traditional IRA is funded with your pre-tax dollars. The money that you contribute to your traditional IRA can lower your annual tax bill. You can put up to $5,500 away each year (and $6,500 annually after age 50). By age 70 ½ the IRS requires you to start taking money out of your account. This is called a required minimum distribution (RMD).
A Roth IRA...
All of the above. The money you use to fund a Roth IRA doesn’t come out of your pre-tax earnings like a 401(k). You fund it with the money you’ve already paid taxes on (your net income). Just like traditional IRAs, Roth IRAs have yearly contribution limits of $5,500 (and $6,500 annually after age 50). Unlike a traditional IRA where you are required to begin taking money out of your account by age 70 ½, you can keep adding to your Roth IRA for as long as you like.
About how much should you aim to save for your retirement?
10-15% of your current income. Experts say that you should ideally save between 10% and 15% of your current income for retirement. However, there is no one-size-fits-all solution when it comes to retiring; it may look a little different for everyone. Depending on when you start, you should aim to contribute more than $5 per month, but less than half of your income.