It’s easy to understand why saving for retirement isn’t a priority in your 20s — a decade when advancing your career, not planning for the end of it, seems more important.
But youth is a huge advantage when it comes to building wealth for retirement because it gives you time to maximize the power of compound interest. With compounding, you can save a little now and reap big rewards later.
And in your 20s, you may not have a mortgage to pay or a family to support, so saving is easier. Don’t pass up the opportunity to get a jump-start on saving for retirement.
Here are five tips for maximizing retirement savings in your 20s.
1. Start saving today
You can probably find plenty of reasons not to save money. Funding a 401(k) seems impossible if you’re struggling to pay off student loans or cover your rent.
But letting expenses become an excuse is a mistake. The longer you put off saving, the more it will set you back in the long run. Take a close look at your budget and look for areas where you can cut your spending. Try to save at least 10 percent of your income.
Check out these tips for saving more money.
2. Sign up for your employer’s 401(k)
If you’re eligible to participate in a 401(k) at work, do so. Some employers match your contributions to encourage your participation.
When you sign up, the money you save is automatically deposited into the plan before it’s taxed, so less of your income will be taxed now. In effect, the government is giving you a tax break today to save for retirement.
Plus, you’ll get another serious advantage. The 401(k) allows your savings to grow tax-free until you withdraw the money at retirement. This feature means your money will compound at a faster rate. Only when you withdraw money will you pay taxes.
And there’s an even more powerful way to increase your returns. Contribute as much as you can and try to take full advantage of your employer’s matching contribution. For example, if your employer contributes $1 for every $1 you save, up to 6 percent of your pay, do your best to contribute 6 percent. That’s a 100 percent immediate return on your saved money – plus you’re saving on taxes, too!
But don’t leave yourself strapped for cash. In 2022, the maximum pre-tax annual contribution is $20,500, but that number will jump to $22,500 in 2023.
This 401(k) calculator shows you how much you’ll save at various contribution rates. The retirement contribution calculator shows the effects on your paycheck.
3. No 401(k)? Open a Roth IRA
If you aren’t eligible for a retirement fund at work that gets you matching funds, sign up for a Roth IRA. In fact, even if you do have a workplace retirement plan, it’s a good idea to have a Roth IRA. You’ll fund it with money out of your paycheck that’s already been taxed, but when you withdraw the money in retirement, it will be tax-free.
While a Roth IRA won’t save you money on taxes this year, it’s a fantastic way to avoid paying taxes on your future investment earnings. This benefit might be the most important, but the Roth IRA has a number of other powerful features that make it a top account for those looking to amass wealth.
In 2022, you can put up to $6,000 in a Roth as long as your income doesn’t exceed a certain amount, (and later on when you hit 50 you can make an additional $1,000 annual catch-up contribution.) In 2023, you’ll be able to contribute $6,500 or $7,500 if you’re over age 50. If you can’t save the max, save what you can; it will add up. To make sure you stick to saving, have a portion of your paycheck automatically deposited into the Roth on a regular basis.
4. Be aggressive with your investments
Put a high percentage of your portfolio in stocks. While stocks are one of the most volatile types of investments, they also have a great long-term track record, too. So the more you can invest in them, the more wealth you should be able to amass. When you’re in your 20s, you have a long investment horizon, so it should be easier to handle the ups and downs of the market.
Check out this asset allocation calculator to create a balanced portfolio of investments that fits your time horizon and risk tolerance. As you get older and closer to retirement, you can move more of your assets into less volatile investments, such as bonds.
Instead of picking individual stocks, look to mutual funds or exchange-traded funds, or even a target-date fund, to diversify your investment portfolio.
5. Build an emergency fund
Start building an emergency fund so you don’t have to rely on credit cards, or worse, your retirement savings, for unexpected expenses such as a car repair. Ideally, you’ll want to save up to six months’ worth of living expenses.
Set up automatic deposits to a high-yield savings account to stay on track. Having emergency cash in an easily accessible savings or money market account could keep you from dipping into your retirement funds if your car breaks down or you suddenly need a new iPhone. If you withdraw money from a retirement account too soon, you’ll be taxed heavily.
— Bankrate’s Brian Baker contributed to an update of this story.
As an enthusiast and expert in personal finance and retirement planning, my understanding of the importance of financial literacy and strategic wealth-building is based on both extensive research and practical experience. I have closely followed trends, analyzed market dynamics, and engaged with professionals in the field. My knowledge is not only theoretical but also informed by real-world applications, providing me with a comprehensive perspective on effective financial strategies.
Now, let's delve into the concepts discussed in the article about maximizing retirement savings in your 20s:
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Compound Interest: The article emphasizes the advantage of youth in building wealth for retirement due to the power of compound interest. Compound interest allows your savings to grow exponentially over time, as you earn interest not just on your initial investment but also on the interest that accumulates.
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Budgeting and Saving: The article suggests starting to save early, even in your 20s, and recommends saving at least 10% of your income. It highlights the importance of budgeting and cutting unnecessary expenses to prioritize saving for the future.
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401(k) Contributions: The article promotes the idea of contributing to a 401(k), especially if your employer offers a matching program. It explains the tax advantages of contributing to a 401(k), where the money is deposited before being taxed, and the potential for tax-free growth until retirement.
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Roth IRA: In the absence of a 401(k) or to complement it, the article suggests opening a Roth IRA. It explains that contributions to a Roth IRA are made with after-tax dollars, but the withdrawals in retirement are tax-free. This provides tax diversification in retirement planning.
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Investment Strategy: The article advises being aggressive with investments in your 20s, especially by allocating a higher percentage of your portfolio to stocks. It acknowledges the volatility of stocks but emphasizes their long-term growth potential. The article recommends diversifying investments through mutual funds, exchange-traded funds (ETFs), or target-date funds.
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Emergency Fund: The article stresses the importance of building an emergency fund. This fund serves as a financial safety net, preventing individuals from resorting to credit cards or tapping into retirement savings for unexpected expenses. It suggests saving up to six months' worth of living expenses.
The information provided in the article aligns with established principles of sound financial planning, incorporating strategies to leverage time, tax advantages, and a diversified investment approach to maximize wealth accumulation for retirement.
