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How to Start Saving for Retirement in Your 20s

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028 - How to Start Saving for Retirement in Your 20s

When I was in my young 20s, retirement was just about the last thing on my mind. I had just graduated from college, started my first professional job, and had my whole life ahead of me to look forward to.

While that may be true, what I realized about a decade later was that your 20s is precisely the right time you want to begin retirement planning. The more you do in your early years, the more luxurious your golden years could be AND you’ll likely have more time to enjoy it.

If that sounds like the kind of life you’d like to have one day, then here are the top five ways you can start saving for retirement in your 20s starting today.

Define Your Goal

There was a time when the word “retirement” would have conjured up images in my head of old men and women eating early-bird dinner specials and playing bingo. But after I started reading books like “The 4-Hour Workweek” and “Rich Dad, Poor Dad”, I realized that your retirement can be anything you want it to be. 

  • You could figure out a way to becoming financially independent by the time you’re in your 30s (yes, that really happens for some people). With no longer having to go to work, you could spend the rest of your days traveling the world and learning new things.
  • Or you could also use retirement as a way to launch into a second career or start your own business. Imagine trading in what you do now to pursue doing a hobby or passion that you’ve always loved.
  • Or you could be like me and simply want to achieve financial freedom (regardless of whether I keep working or not).

The choice is yours! But to get there, you first have to determine what your vision of retirement will look like and how badly you want to get there. Your goals coupled with your income will help determine how much you should be saving for retirement in your 20s.

Even if you’re in your 20s, spend some time reflecting on what you’ll want to do. If you’ve got a partner, make sure that you talk about it with them too since their idea of retirement may influence how the two of you ultimately decide to spend it.

Join Your Employer’s 401k Plan

Most young people will have no idea what a 401k is until they start their first professional job (I sure didn’t). But trust me – it’s something you’re going to want to start taking advantage of right away, especially if you want to maximize the benefits of saving for retirement in your 20s! So set up a 401k as soon as you get your first professional job. If you’re self-employed you can start a 401k for yourself under your company’s name.

For starters, a 401k lets you avoid paying taxes on any income that you save towards retirement. You instead get to defer those taxes until decades later when the IRS says you can withdraw them after age 59-1/2. 

With a maximum savings limit per year of $19,500 (as of 2021), that’s like getting a free pass to skip paying the IRS $4,290 in taxes (assuming you’re in the 22% tax bracket).

But then a 401k gets even better. As a way to encourage employees to participate, most employers will also kick in additional money called matching contributions. It’s basically free money that they’re giving you just for being a good saver.

Matching contributions can be as much as dollar-for-dollar (up to some limit). For the sake of argument, let’s say your employer is going to give you an extra $3,000 per year in matching contributions. If that was invested in a stock market index fund earning approximately 10% per year, then after 30 years it would be worth $493,482.

And all of it is also tax-deferred!

Open a Roth IRA Too

A 401k isn’t the only way to save for retirement in your 20s. If you’d like to have tax-free income by the time you retire, then you can also open what’s known as a Roth IRA.

Roth IRAs work the opposite of a 401k. With a Roth, you pay taxes on your income now and then owe the IRS nothing later on. That means all the money you earn on top of your savings is also completely tax-free by the time you retire.

You can open a Roth IRA in your 20s with any financial institution of your choice. In fact, most robo-advisors will give you this option if you open an account with them.

Set Up Autopay for Savings

Establishing the mindset for saving for retirement in your 20s is not easy, but modern technology has made saving convenient and easy for everyone. One of the best ways for you to save for retirement in your 20’s is to sign up for a savings account with an autopay feature that deposits money into your savings account, 401k or IRA on a monthly basis.

Setting your savings on auto allows you to constantly save the same amount each month and is a deposit that you can expect like any other bill. The difference is that you’re paying yourself now in order to better your future.

Of course to really leverage the maximum benefit in your retirement, try your best to make the percentage of savings as large as possible, especially if you don’t have significant responsibilities. Automatic debits are one of the best ways to save for retirement in your 20s and also to encourage good financial habits from an early age.

Save for an Emergency Too

Saving for retirement in your 20s or contributing money to your 401(k) is of no use if you have to sooner or later withdraw from it every time you face an emergency in your life. Setting aside funds in a high-interest savings account to cover for expenses in a worst case scenario is essential – it’ll take care of emergency situations that may arise if you lose your job, your business runs into losses, or if an ailing family member needs medical care that is not covered under health insurance. You’ll be thankful later if and when such a situation ever emerges, which will help you to avoid pulling money from your retirement savings to meet the costs.

If you don’t have an emergency fund, start by saving two months worth of expenses, with the ultimate goal of saving 6 months worths expenses, which will keep you and your family protected during even the rainest days in your life.

Keep Debt to a Minimum

Using credit cards is a great way to improve your credit score but that is only applicable when you pay off your debt on time! So be sure to pay off your credit card debt within a period of 30 days to avoid accruing interest charges. And regularly paying off your credit card purchases is a great way to avoid running up a huge debt that becomes unmanageable later.

Besides credit cards, this golden rule applies to all other types of debt. Again, to keep debt to a minimum, it’s best to only use credit cards to purchase things that you were already going to buy. Doing this ensures that you can pay the debt immediately, without ranking up interest charges or additional debt.

Build a Strong Credit Rating

Make efforts towards building an above average credit score which can lower the cost of borrowing money, whether it is for a home mortgage or any other financial need. It mayalso increase your credit limit, but of course a high limit does not mean you splurge on things beyond your means – if you have to pay a high interest on debt incurred, it may not only negate the gains derived from savings or investments but you may end up losing everything you worked so hard for.

A great way to do this is by using your credit card periodically. But remember, only use your credit cards to pay for things you can afford.

Save Until It Hurts

I remember when I started my first professional job, I started off saving 10% of my income for retirement. But with my retirement goal in mind, I eventually ramped that up to 15% followed by 20%. And then after a few years, I was saving as much as the IRS would allow!

Whenever someone asks me “how much should I be saving for retirement in my 20s?”, my answer is always very simple: Save until it hurts. By this, I mean you should save as much money with every paycheck to the point where you’ve got almost nothing leftover when you’re done paying your bills.

Why do this? Because over time it will help you to become more disciplined with your spending habits and prevent lifestyle inflation from creeping in as your income starts to rise. Meanwhile, the more you increase your savings rate, the closer you will get to your vision of retirement.

Invest Aggressively

One mistake a lot of my friends made when they started their 401k plans was to avoid investing in funds made up of aggressive stocks because they thought they were too risky.

But playing it safe cost them when my portfolio of aggressive-style funds was nearly double the value of theirs after just 3 short years.

Throughout history, the stock market has outperformed every other type of asset (bonds, currency, precious metals, real estate, etc.). This is all thanks to the awesome power of compound interest.

To illustrate this point, if you had invested $100 back in 1928:

  • Putting it into the S&P 500 stock market index fund would have turned it into $592,868.
  • Putting it into 5-year treasury bonds would have returned $8,921.

That’s quite the difference!

But aren’t stock funds risky? Yes, of course. But remember – you’re in your 20s! Aggressive investing in your 20s gives you plenty of time to ride out the ups and downs of the stock market. This could make all the difference for when you go to retire, because if you wait until you’re older, market crashes or other times of volatility may prevent you from retiring on time.

Over the long haul, stocks are going to produce a positive return. So as long as you put any market jitters aside, you’re going to be giving your nest egg the best chance you can of letting it grow to its full potential.

Final Thoughts

Thinking about how to save for retirement in your 20s may seem like the last thing on your mind. But the sooner you begin, the easier it’s going to be to accomplish everything you’ll eventually want to do.

Let your vision of retirement motivate you to participate in your 401k plan and save until it hurts. Remember also to invest aggressively so that you’ll maximize your chances for growth.

Believe me – by the time you’re in your 30s or 40s with hundreds of thousands more dollars than your peers, you’ll be glad you got started with saving for retirement in your 20s.

Contributor’s opinions are their own. Always do your own due diligence before investing.

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Written by DJ Whiteside

DJ writes about retirement and credit cards. He loves looking for new ways to optimize savings, build wealth, and sharing what he learns with others.

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