Retirement Savings Guide for 20-Somethings

Learn how to get your retirement savings on the right path from your 20s and beyond. See which are the best retirement plans for millennials.
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By Richard Barrington

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Retirement seems a long way off when you’re in your 20s, but that is the ideal time to start saving for it. In fact, you could argue that for most people, it is essential to begin building your retirement savings before age 30.

The sooner you start saving for retirement, the more years you will have for your money to grow on your behalf. Plus, starting early makes it easier to establish the good savings habits that pay off in the long run.

That’s not to say it isn’t challenging. You may be just squeaking by on an entry-level salary, with student loan payments looming. It may seem impossible to even think about saving for retirement under those circumstances. But don’t worry – you don’t have to get there all at once.

You can take it step-by-step, first by getting control of your finances, then by starting to take advantage of tax deferrals, and finally by fine-tuning your retirement saving approach to put you on course for a comfortable future.

How to prepare finances for retirement saving

You can’t start saving until you get a handle on your regular spending, so here are some preliminary steps to put you in a position to save:

1. Establish a budget

Starting out, people often find themselves scrambling just to meet expenses as they come up. This makes it difficult to carve out any room for saving money. The solution is to establish a budget by tracking expenses, deciding which are most important, and allocating a set amount of money each month towards those expenses. Be sure to keep your spending below what you earn, and leave some room for savings as well.

2. Save at least half your next raise

Even after establishing a budget, people on relatively low incomes find it difficult to find room in that budget to save money. If that’s the case for you, a good way to get started is to save at least half your next raise. That way, you’ll be able to start saving regularly without cutting into your existing budget.

3. Build an emergency fund

As a preliminary step before starting to save for the long-term, it may be helpful to build an emergency fund equal to about three to six months’ worth of expenses. This will help you be prepared for unexpected setbacks, and get you in the habit of saving money.

Tips to start saving for retirement in your 20s

Once you have an emergency fund in place, it is time to start putting your saving budget towards retirement. It is easiest to do this if your employer has benefit plans in place, but you can do it even if that is not the case. Formal retirement savings programs generally have tax deferral features which allow you to invest more of your paycheck rather than sending it to the government in taxes. Here are some steps to consider:

1. Don’t settle for automatic enrollment on an employer’s plan

If your employer has a 401(k) retirement plan or similar type of plan, there might be an automatic enrollment feature which automatically sets a side a portion of your paycheck to go into that plan. Chances are, you can and should contribute more than that, so don’t assume that automatic enrollment amount is enough to prepare you for retirement.

2. Take full advantage of any employer match

Some employer-sponsored plans have matching features. This means the employer will kick in a certain portion to match your contributions. This is basically giving you extra money, so your immediate goal should be to contribute enough to take full advantage of any employer matching dollars.

3. Participate in a Health Savings Account

Your employer might also offer Health Savings Accounts (HSAs) which allow you to save money for medical expenses tax-free. While people often use these to fund immediate expenses, note that HSAs can also be used to save long-term for future expenses, which comes in handy because health care is a big expense in retirement.

4. Set up an IRA if your employer does not have a retirement plan

If your employer does not offer benefit programs like a 401(k) or an HSA, you can take advantage of tax-deferred retirement savings by setting up an IRA. You have a choice between a Roth IRA and a traditional IRA. A Roth IRA requires you to pay taxes up front but then your investment earnings are tax-free. A traditional IRA allows you to put off paying taxes until you draw the money out in retirement. Since this is a choice of paying taxes now or paying them later, a Roth IRA often makes sense for younger people who are in lower tax brackets than they are likely to be in when they are older.

Just note that the tax-deferral features of retirement plans come with one important catch – there is generally a penalty if you take money out before retirement.

How to meet your retirement savings goals beyond your 20s

Once you get in the habit of setting money aside, you can start gearing those savings towards your retirement needs:

1. Start running retirement projections

A variety of online retirement calculators are available that will help you figure out how much money you will need in retirement, and how much you will need to save from week to week to meet that goal. Start experimenting with these calculators to get a feel for what level of savings you will need.

2. Move beyond default investment options

Along with automatic enrollment, many employer-sponsored plans have a feature that automatically directs employee money into an investment option assumed to be appropriate to their needs. That’s fine when you first get started, but not everybody has the same needs. The more you get a handle on your retirement goals, the more you should be shifting your money into options better suited to meeting your specific needs.

3. Ramp up your retirement contributions

Remember that advice about starting to save by setting aside at least half of your next raise? Do this with each raise you get, and it will help build your retirement contributions towards the level necessary to meet your goals.

4. Re-adjust your goals and investments regularly

Don’t just set a course and leave it. Your goals may change, and your investments may perform differently than expected. At least once a year re-run your retirement projections and evaluate whether your saving level and investment choices are still well-aligned with your goals.

No goal as big as retirement saving is reached all at once. Each of the above is a reasonable step you can take to get you a little closer to that goal. The most important step of all is getting started.

Frequently Asked Questions

Q: I have $250,000 in a federal TSP. I retire in May of 2014 at age 50, and plan to work for about five years after I retire making approximately $16,000 a year. I can’t get money out of the TSP or an IRA without a tax penalty until age 59 1/2, but I plan to buy property outside the United States and want to make sure I have the money available when I find the right property — for which I am willing to pay taxes and penalties, which I figure will leave me with about $175,000. Am I better off keeping it in a savings or money market account within the TSP, or shifting it to an IRA?

A: To address first the pros and cons of staying in your federal Thrift Savings Plan (TSP) or shifting to an IRA, that depends largely on how the savings and money market account options within the TSP compare to similar accounts on the open market. You could start an IRA at a wide variety of banks, which would give you more choice when looking for a savings or money market account. If you see a clear interest rate advantage outside the TSP, it might be worth shifting to an IRA.

There are a couple of concerns about your plan that bear raising. First, have you carefully examined your cash flow needs to determine if you can really live on $16,000 a year in semi-retirement, and on potentially less than that when you stop working? Real estate is not a very liquid investment, so unless you plan on investing in a thriving rental property that will provide you with immediate income (after subtracting expenses like taxes and upkeep), you should be concerned about tying up a large portion of your retirement assets in an illiquid asset.

The other concern is with taking the 10 percent tax penalty for early withdrawal. That would amount to throwing away $25,000. Is there really a property investment so compelling that you feel it could make up for that $25,000 between now and when you turn 59 1/2, at which point you could make the withdrawal without the penalty? Have you thought about trying to get a mortgage to buy the property, which would require less cash flow now and allow you to pay it off once you are able to withdraw from the TSP without penalty at age 59 1/2? You may even be able borrow some of the money you need from the TSP, rather than withdrawing it.

About Author
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Richard Barrington
Richard Barrington has been a Senior Financial Analyst for MoneyRates. He has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications. Richard has over 30 years of experience in financial services. He has earned the Chartered Financial Analyst (CFA) designation from the Association of Investment Management and Research (now the “CFA Institute”).