Starting early with investing for retirement is so important to secure your future self. This means that saving for retirement should be a component of your overall financial portfolio and wealth-building strategy. By starting early on, you put yourself in a position to build a substantial nest egg that the future you will be grateful for. So, let’s discuss how to save for retirement in your 20s!
Table of contents
- Why saving for retirement early matters
- 1. The 401(k) Plan
- 2. Traditional IRA
- 3. Roth IRA
- 4. The self-directed IRA
- 5. The Solo 401(k)
- 6. The SEP-IRA (AKA Simplified Employee Pension)
- Expert tip: Understand your risk tolerance
- How to save for retirement in your 20s when you’re just starting out
- How much should I contribute to my 401(k) in my 20s?
- Here’s what happens when you take money out of your retirement account
- How to avoid withdrawing money early
- Should I roll over my old 401k to my new employer’s plan?
- How much should you be saving for retirement in your 20s?
- How do I start putting money away for retirement?
- How much should I contribute to my 401k in my 20s?
- Articles related to preparing for retirement
- Retirement planning in your 20s: Start saving now!
Why saving for retirement early matters
Saving for retirement early is essential as it can you help you create a solid financial base. This ensures that you’ll have sufficient savings for a comfortable retirement, even if career interruptions happen along the way.
Early savings also means that you are creating financial independence for yourself, lowering your reliance on social benefits and reducing financial strain in retirement.
Unfortunately, 56% of workers feel that they don’t have enough money for retirement, which is why it’s important to get started saving immediately.
But don’t worry, retirement saving isn’t as complicated as it seems! Here, you’ll find answers for everything from “How much should I contribute to my 401k in my 20s?” to “What are my options for saving?”
There are many retirement accounts to choose from when figuring out how to save for retirement in your 20s.
First, of course, you need to pick the right account that aligns with your financial situation and goals. Let’s discuss them below!
1. The 401(k) Plan
A 401(k) is an employer-sponsored retirement account into which you can contribute part of your pre-tax income. Many employers who offer the 401(k) plan will offer a match up to a certain percentage.
For example, a common matching contribution plan matches 50% for annual contributions up to 6%. If you make $100,000 and contribute 6% (or $6,000) to the plan, your employer will contribute an additional $3,000.
The great thing about the 401(k) plan is that you get to save the maximum amount of your income before taxes. But keep in mind that when you retire, your funds will be taxed at whatever your tax bracket is at that time. So, when you calculate retirement, planning for taxes is a must!
In addition to the traditional 401(k), many employers offer a ROTH 401(k) to their employees. Funds contributed to a ROTH account go in post-tax. Post-tax means your savings come out tax-free in retirement.
There are a few other types of employer-sponsored plans as well: 403(b) and 457(b) plans. These plan types are almost identical to the 401(k) plan. They are offered to people who work as educators, in government, or in non-profit organizations.
A personal 401(k) story
A while back, I posted a picture on Instagram of an old 401(k) statement. I started this 401(k) account with a zero balance.
Over a 4-year timeframe, I saved $81,490, which included my 401(k) match. Shortly after I shared that post, someone left this particular comment:
“401(k)s are for chumps. Two-thirds of that money will be gone in taxes, (and) fees that you don’t know about, and that they are legally allowed not to tell you about.
You will be taxed at the rate at which you retire, which will be more than you are today. Inflation will cut that by 2% every year.
It’s a big game and you are falling for it. Why would you put your money in a 401(k) when the banks just print more money?”
I’ll be honest and say that yes, I agree with a portion of their comments, but this person is not right about everything with 401ks. Which brings us to the pros and cons.
Pros and cons of a 401(k)
Additionally, 401(k) contributions are before tax. That means when you start to withdraw it, you will be paying tax at whatever your future tax rate is. Future tax rates are hard to predict, but they could very likely be higher than the present day.
However, even though there are a couple of drawbacks of a 401(k), the advantages far outweigh them when planning how to save for retirement in your 20s.
401(k)s are a great way to gain investing experience
Before being exposed to a 401k, many people have never really had the opportunity to invest in the stock market. A 401(k) provides that opportunity and allows it to happen painlessly through automatic deductions from your paycheck.
There is a great opportunity for pre-tax contribution growth
The growth of your pre-tax contributions may far outweigh any taxes or fees you incur when it’s time to withdraw from the account. However, this is not a guarantee.
In addition, the growth from your employer’s 401k matching may be able to take care of some or all of those taxes and management fees you incur.
Retirement is not a specific date; it’s a period of time that lasts for several years
Retirement can last upwards of 20+ years. That means when you retire, you won’t be withdrawing all your money at the same time. Your money still has more time to potentially keep growing.
Your money doesn’t need to stay in your 401(k) forever
Most people do not stay at their jobs from when they first graduate college until they retire. A classic example is me! I switched jobs four times over an eleven-year period before I started working for myself.
When you leave a job, you can roll over your 401(k) money into an individual account. You are not stuck there forever.
2. Traditional IRA
This is a type of retirement account that you can set up individually, independent of an employer.
Pros and cons of a traditional IRA
The biggest benefit of a traditional account is deferring taxes till retirement. You won’t pay taxes on funds when you put them into the account. As most people have a lower tax bracket after retirement, this means you’ll ultimately pay less in taxes when you withdraw the money later.
Additionally, a traditional account gives you much more flexibility in investing than employer-sponsored plans. Generally, you can invest in almost endless investment options, such as stocks, mutual funds, or bonds.
IRA contribution limits, however, are much lower than 401(k) limits. And if you take out money before you are eligible (age 59 1/2), you will be subject to income tax and a 10% penalty.
3. Roth IRA
This account type is similar to a traditional account but has some key differences.
First, your contributions are made post-tax, which means there is no deferred tax benefit.
In addition, the earnings on your funds will not be taxed come retirement age. You can make withdrawals on your contributions before you are eligible without any tax penalties, according to Charles Schwab.
Pros and cons of a Roth IRA
While a traditional IRA gives you potential tax savings when you contribute funds, a Roth helps you save on taxes in retirement. Money that you put into a Roth goes in post-tax, meaning you’ll pay taxes before depositing it.
However, you get to take your money out of the account tax-free in retirement.
Like a traditional account, Roth accounts also give you the chance to invest according to your risk tolerance.
However, Roths also have lower contribution limits than 401(k) accounts.
Traditional or Roth IRA? Which is best?
They are both great ways to grow your retirement funds. But to choose between the two, you have to determine what works best based on what you think your future tax bracket will be.
For example, if you think your future tax bracket will be lower than what you currently pay now, then a traditional account might be best for you since you don’t pay taxes until later.
However, if you think your tax bracket will be higher than what you pay now, then a Roth might be best for you since you would have already paid taxes on your contributions.
Many people have both types of accounts because you can have multiple IRA accounts. Ultimately, they are able to save more by leveraging the benefits of these plans over time.
4. The self-directed IRA
A self-directed IRA is a type of individual retirement account that is governed by the same IRS rules as traditional and Roth accounts.
However, unlike the other types, a self-directed account can unlock access to alternative investments, for example, real estate.
Pros and cons of a self-directed IRA
There are pros and cons to a self-directed IRA, as explained by NerdWallet. The main benefits of a self-directed account include:
- Ability to invest in a range of alternative investments
- Potential for higher returns through diversification
However, self-directed accounts also come with disadvantages, such as:
- Fees may be higher for self-directed accounts
- May have a higher risk of scams or fraud due to less regulation
- Some alternative investments have low liquidity, making it difficult to withdraw funds
5. The Solo 401(k)
This plan is specific to those who are self-employed but have no full-time employees. Essentially, a solo 401(k) lets self-employed people create a 401(k) plan for their business. It can be a great option if you’re self-employed and trying to figure out how to save for retirement in your 20s.
Pros and cons of solo 401(k)
The advantages of a Solo(k) include:
- Many benefits of a traditional 401(k) that self-employed people otherwise wouldn’t get access to
- Business owners can contribute both as an employee and employer, maximizing contributions
- Spouses who get an income from the business can also contribute to the plan
- Higher contribution limits than other common options for the self-employed.
The downsides of a solo 401(k) include:
- Only available for self-employed people
- Added administrative duties for the business owner, such as filing tax forms
- Contribution limits are tied to income, so if your income fluctuates, your contributions could be affected
6. The SEP-IRA (AKA Simplified Employee Pension)
The Simplified Employee Pension allows the self employed and business owners to contribute up to 25% of employee’s earnings to IRAs for their employees up to a certain amount, tax-deferred.
It’s based on employer contributions only, and each eligible employee (if you have them) must receive the same contribution percentage from you as the employer.
Pros and cons of the SEP-IRA
The main benefits of an SEP include:
- Easy to set up and maintain as opposed to a 401(k) plan
- Relatively high contribution limits
- Contributions can be flexible based on the profit of the business
- There are no ongoing tax filing requirements for a SEP plan, the U.S. Department of Labor notes.
The cons of a SEP include:
- No employee contributions
- Employers must contribute to all eligible employees
- There are no catch-up contributions for older employees
- No ROTH option is available for a SEP
Expert tip: Understand your risk toleranceYour time horizon is the amount of time you will hold an investment. Generally, an investment fund with a later date can take on higher risk than one with a nearer date.
It’s important to decide how risk averse you want to be throughout the years. And if you choose to, it’s okay to make changes if you want to. Knowing your risk tolerance can help you plan for the long term future.
How to save for retirement in your 20s when you’re just starting out
Now that you are familiar with the different types of retirement accounts, it’s time to get started with retirement planning in your 20s!
But what if you’re just starting out and don’t earn much? Whenever the topic of saving for retirement comes up, I am often met with statements similar to the following:
“I don’t earn enough to save for retirement.”
“I’m waiting to get a better job before I start saving.”
“I’ll play catch up when I earn extra income.”
While entering the workforce can be exciting—you’re finally out on your own!—it can also be overwhelming. And if you’ve got an entry-level salary, it can be tempting to skip saving for retirement.
However, there are plenty of ways to save for retirement while dealing with an income that’s lower than you plan to make in the long run.
1. How to start saving for retirement with the right investments
The first step to saving for retirement is finding the right accounts and simply getting started. Many jobs offer employer-sponsored retirement accounts like a 401(k). You can also save for retirement through non-employer accounts like an individual retirement account.
The investments you choose will generally depend on your personal risk tolerance.
However, most financial experts agree that you can be more aggressive with your investments in your 20s because you’ll have more time for market corrections. That means it could be worthwhile to invest in riskier vessels, such as individual stocks, over lower-risk investments, like investing with index funds.
Still, it’s a good idea to diversify your accounts as well—meaning you shouldn’t put all of your savings into one type of investment.
Although you might be earning a starting salary, you can start by contributing as little as 1% of your salary to your savings. Then, make 1% increments for each raise you receive.
Even though it’s a small amount—you probably won’t notice much of a difference in your paycheck— you’ll be saving a substantial amount of money over the years.
2. Get the free money from your employer
What types of retirement options does your employer offer? When you take a job, your human resources department typically provides information on plan options. Many employers offer a 401(k) or 403(b) plan for employees.
Be sure to ask your employer about potential retirement options to see what they offer.
If your employer offers a 401(k) or 403(b) savings match, take it. So many people do not take advantage of their employer-sponsored match.
That’s a big mistake because you essentially get free money! If you are just getting started with saving for retirement, you can set an initial goal to contribute just enough money to get the match.
3. Leverage other options
If you don’t have access to a 401(k) plan through your employer, then consider 401(k) alternatives. They include setting up a traditional and/or Roth IRA through your bank or via a brokerage firm.
The saving maximums are lower than a 401(k) or 403(b), but you can still save a lot of money over time.
In addition, if you’re learning how to save for retirement in your 20s, you’ll likely also need to learn how to save for other expenses.
Starting an emergency fund stored in a savings account is an important aspect of a healthy financial plan as well. It helps you cover the unexpected costs that could come up in life—from a broken-down car to sudden medical bills.
4. Automate your savings
After you’ve calculated your retirement lifestyle needs, you should make saving easier by automating your finances. How?
Have funds automatically taken from your paycheck directly into your account. 401(k) and 403(b) deposits are usually automatically pulled from your paycheck.
However, if, for some reason, your deposits are not automated, make a payroll request to make it happen.
Automatic transfers take the stress out of saving. And you’ll never forget to make a transfer again! Plus, you won’t get the chance to overthink whether or not you should make the transfer.
Have an inconsistent income? Just not ready to automate? Then, set reminders on your phone around each pay period, reminding you to make those transfers to your retirement accounts!
Putting off retirement contributions until you make more money? Not a great idea when learning how to save for retirement in your 20s.
Doing so basically means that you could have to work longer than you expected in your old age and/or have to rely on government assistance to survive.
By putting it off, you lose valuable time to take advantage of the power of compounding— the key to growing your money over time. So, if you’re wondering what to do with savings, start with what you can save now, no matter how small it might be.
How much should I contribute to my 401(k) in my 20s?
A key consideration to make is to determine how much you need to save before retiring from work.
The easiest way to calculate retirement numbers is to use calculators. Here are a few of our favorite calculators to get you started:
Here’s what happens when you take money out of your retirement account
I’ve seen so many instances where people think of their retirement as their emergency cash or as savings for their short-term goals.
They feel they can leverage the money for minor emergencies, non-emergencies, and other financial obligations or goals they have.
But is this okay? My thoughts? It really isn’t a good idea unless it’s a dire emergency.
Withdrawing or loaning money from your retirement fund can have adverse effects on your wealth-building efforts for several reasons.
You will lose the potential longer term gains/earnings you would get if your money remained invested and was working for you. You will also lose out on earning compounding interest when you take money out of your accounts.
Additionally, if you withdraw your money before your eligible retirement age, you may be liable to pay income taxes as well as an additional penalty (10%) on the total amount withdrawn.
What does this look like in actual numbers?
Withdrawing money from retirement
Let’s say that right now; you are considering taking $1,000 out of your retirement accounts. Let’s also assume that the average return on your investment for the next year is ~8%.
At the end of that year, you’d have $1,080 in your account. Another year into the future, based on annual compounding with a return of 8%, you’d have more than $1,160 in 2 years from an original investment of $1,000.
Impact of an early withdrawal
If you decide to take this $1,000 out early, you’d have to pay the following (assuming a 30% tax rate):
- Early withdrawal penalty – 10% = $100
- Federal & state tax withholding = $300
The balance you would receive would only be $600.00
Taking a loan from your retirement savings
If you decide to take out a loan, depending on the timeframe of your loans, your $1,000 will miss out on the potential earnings and compounding. As with any loan, you’ll have to pay interest on the balance.
And like many people who borrow from their retirement accounts, you might have to reduce or stop your retirement contributions altogether to be able to make the loan repayments. So, the lost opportunity is even greater.
However, if you left that money alone for 10 years, the potential future value of your $1,000 could be $2,159. A scenario like this assumes an average return of 8% over that 10 years (based on the historical performance of the stock market over time). Since this is an average return, it would be despite spikes and dips in the stock market.
$600 vs. $2159. The difference is major.
And this is only based on $1,000.
If it was based on $10,000, it would be a difference of $6,000 vs. $21,589.
Yup, let that sink in.
How to avoid withdrawing money early
It’s important to avoid dipping into your savings. Here are a couple of tips to help you build a better budget for emergencies and other expenses.
Build up your emergency savings
To start, it’s important to focus on building a solid emergency fund. Your goal should be 3 to 6 months, but more is better, such as a 12-month emergency fund. That way, if you need some extra cash due to an unexpected occurrence, you can leverage your emergency savings instead of your retirement money.
Don’t have an emergency fund in place yet? Set an initial goal to get to $1,000 or more ASAP. Then, after paying off any high-interest debt—like credit card debt—ramp up your emergency savings to 3 to 6 months of basic living expenses.
Start saving for your short to mid-term goals
Next, create savings for your short to mid-term goals. It’s basically the money you need to have access to in less than 5 years, like buying a house, taking a trip, or buying a car.
Building these saving goals into your monthly expenses list will help ensure you are allocating funds toward them each paycheck. Over time, you’ll be surprised at the progress you make.
Should I roll over my old 401k to my new employer’s plan?
Yes, when it comes to what to do with your old 401k, you can roll it over from one employer to another if permitted by your new employer.
But it’s important to keep in mind that, in many instances, employer-sponsored plans can be limited in terms of the options you can invest in.
If you are moving jobs, it’s better to move your retirement funds into your own account with a brokerage firm like Betterment, Vanguard, or Fidelity. There, you have access to the entire stock market and potentially much lower fees. I’m a huge fan of index funds because I know exactly what I’m paying in fees.
How much should you be saving for retirement in your 20s?
The easiest way to determine how much to save for retirement at this age is to simply save what you can.
Many people at this age are in the early stages of their career—and adult life. So, you might not have as much money to put toward retirement as you will when you establish yourself in the world.
Hopefully, you’ll be able to at least build an emergency fund and meet your employer’s 401(k) match if you have one.
However, if you have a lot of high-interest debt, such as from credit cards, you should focus on learning how to stop paying credit card debt by paying it off.
Additionally, start saving some money for retirement.
How do I start putting money away for retirement?
The first place to start is to look at savings options from your employer. A 401(k), for example, is an employer-sponsored account that generally automatically contributes money to your account from your paycheck. All you need to do is sign a few forms through your human resources department.
If you don’t have access to an employer-sponsored account, you can look into individual retirement account options. And you may choose to open an IRA in addition to your workplace 401(k).
To open an account, you’ll have to reach out to a bank, brokerage firm, or financial advisor.
How much should I contribute to my 401k in my 20s?
I suggest starting with a retirement calculator to get a general idea of what you might need to meet your lifestyle in retirement. Then, you can break down how much you need to contribute to reach that goal.
Remember, retirement isn’t a short time period. Most people in the U.S. retire in their 60s, according to Madison Trust Company. And from there, you may be in retirement for 20 years or much longer.
The unknowns make it difficult to know how much you should contribute to your 401(k).
However, it’s worth noting that the longer your money is invested, the more time it has to grow. So, contribute what you can and take advantage of things like employer matches.
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Retirement planning in your 20s: Start saving now!
Don’t ever let ANYONE make you feel stupid for making smart money decisions. Do your research, determine your investment objectives, have a plan that you adjust as necessary, and stay the course when it comes to pursuing your financial goals.
If I didn’t know anything and was just starting out with my 401(k), people complaining about high fees and limited investment options might have stopped me from investing in the account. Based on their misguided advice, I could very well have invested nothing, gotten no free match, and lost out on the chance to build additional wealth by investing in my 401(k).
Don’t let that happen to you! Save early—even if it’s not much—so you’re better prepared for retirement. If you start building wealth in your 20s, you’ll be in a great place financially when you retire.