Financial Advice for 20-Somethings: Retirement Savings

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Start Saving for Retirement Today

As a 20-something, I’m finding more often than not that I’m in great need of guidance when it comes to financial decisions. Thankfully, I have people within my reach that are much more money-savvy than I. They’re who I turn to with any and all of my questions about managing money. With a little help and constant evaluation, I feel like I’m starting to build a solid platform for the future of my finances.

Speaking of the future, I think one of the most important lessons I’ve learned is that our 20s is the ideal time to start saving for retirement. You don’t want to contribute to the rising number of people who are less and less financially prepared for their golden years.

I know that for most 20-somethings retirement is something far-off in the distance, somewhere completely off the radar. However, there are several reasons why you should be thinking about it, and more importantly, actively contributing to a retirement fund.

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Fewer Responsibilities

The best reason why people in their 20s should start saving for later in life: Right now we are at a time in our life where we don’t have extensive financial commitments. If settling down, buying a house and starting a family are part of your plan, make an effort to add “retirement savings fund” into your monthly personal budget before you make any of those leaps. If you create the idea that this fund is just another bill and you automatically deposit the money, you’ll quickly learn to live without it.

The more you can put away in these early years, the longer this money can grow. Then when you are starting to take on more commitments (like a mortgage payment, kid’s college tuition fund, grocery bill for 3+, etc.), you can make adjustments to your contribution level, but will still have that strong foundation on which you can continue building.

Compound Interest

Sometimes you just can’t ignore the numbers. Compound interest is one demonstration of mathematics at its finest. Simply put, compound interest is interest that over time is added to the primary balance, meaning you earn interest on your contribution AND the account interest. In this case, I believe examples speak louder than definitions:

Starting at age 25 $5,000 a year at 8% for 10 years* $5,000 a year at 8% for 40 years*
Year 1 $5,400 $5,400
Year 2 $11,232 $11,232
Year 3 $17,531 $17,531
Year 4 $24,333 $24,333
Year 5 $31,680 $31,680
Year 10 $78,227 $78,227
Year 15 $114,941 $146,621
Year 20 $168,886 $247,115
Year 30 $364,613 $611,729
Year 40 $787,171 $1,398,905

The first column displays the amount one would have if he contributed $5,000 a year from age 25 until age 35. The second column shows the calculations for someone who continues contributing $5,000 a year until age 65. Although the first person only contributes $50,000 to his fund and the second contributes $200,000, the application of compound interest makes both investments much more powerful in the long run. However, if you don’t start early, you lose the power that time can have on your money.

Here’s a calculator from the Council of Economic Education that allows you to enter your own savings goal and watch how compound interest makes your investment grow.

Depending on how often your funds compound (monthly vs. yearly) and what rate of return you’re expecting, you could see your investment grow exponentially before you even reach your 50s.

No Excuses

Maybe the reason you’re hesitating to start saving isn’t because the interest isn’t there, but rather, you aren’t sure where to go or how to do it. There’s a wealth of information out there, but it’s hard to know who to trust or what option will be best for you. If this is the force holding you back, look no further. Here’s my plain and simple, retirement savings low-down:

A 401K is a retirement savings plan, often offered through your employer. In the case of a traditional 401(k), all of the contributions you make are taken out of your paycheck before taxes. With this type of retirement fund, you’ll have to pay taxes when you withdraw that money at retirement. With a Roth 401(k), taxes are taken out of your contribution up front, meaning you pay nothing to withdraw those funds at retirement. If you think you’ll be making more money when you retire than you are now, and thus will be responsible for paying more in taxes, you may want to consider the Roth 401(k) over the traditional one.

Depending on the program offered at your company, a percentage of the amount you contribute may be matched; that means free money! Just think of that as a bonus for good financial behavior.

As the years go on, your money and interest grows in your account. Of course, like any other investment, there are a few things to double check, including limits on how much you can put into the account each year, rules about withdrawing your money, and where your contributions are being invested.

  • Traditional IRA

An Individual Retirement Account, or IRA, is how one saves money for her retirement outside of government or employer-sponsored benefits. This is a personal account that you will have to set up and contribute to on your own. As with a 401(k), the amount you contribute to your IRA is deducted from your taxable income and you don’t pay any taxes on your savings until you start making withdrawals.

The contribution limits for IRAs are much lower than that of a 401(k); however, there is usually a much wider range of investment options when it comes to these accounts. One last side note about money in your IRA: You can add to it until tax filing day of the following calendar year—meaning you have more than a month left to make your contribution.

  • Roth IRA

A Roth IRA has a lot of the same perks as a Traditional IRA with one big difference: The money you contribute to this account is not tax-deductible. You pay taxes on your contributions up-front, meaning that your withdrawals are tax-free. This is pretty convenient for people who don’t like the idea of putting a lot of money away to watch a chunk of it be taken with taxes when they need to withdraw it.

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If you’re still unsure about whether or not you should start saving for your retirement, talk to your parents or grandparents. Ask them about their choices and goals, and if things ended up just the way they wanted. Learning from their example, you can either make a change so your path is different or follow in your family’s footsteps.

For more tips for the young financier, plus free tools to improve your financial health, check out Quizzle.com, where you’ll learn how to achieve your credit potential and get home loan recommendations tailored to your unique situation.

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*Data comes from Bankrate retirement income calculator

  • James Morgan – Puritan Financial Advisor

    The contribution limits for IRAs are much lower than that of a 401(k); however, there is usually a much wider range of investment options when it comes to these accounts.