Planning for retirement is important at every age, including for individuals in their 20s. However, people in this age group sometimes believe they can put off retirement planning until they’re older.
This can be a big mistake for several reasons, the biggest of which is the lost earnings opportunity. Every year that planning for retirement is delayed is a year of lost earnings that can never be recaptured.
Don’t Delay — Start Now
The most important retirement tip for many people in their 20s is simple: Get started now. Doing so enables you to take advantage of compounding of returns over the long term.
With compounding, you earn money not only on the amount of your initial investment, but also on the money that your investment earns. An example helps illustrate the power of compounding when it comes to planning for retirement.
Mark opened an individual retirement account (IRA) at age 22 when he started his first job after college. Now 25 years old, Mark has amassed $5,000 in retirement savings. If he never saves another penny for retirement, his IRA would be worth approximately $75,000 when he turns 65, assuming a 7% average annual return compounded annually.
Mary, on the other hand, waited until she was 32 years old to open an IRA, amassing $5,000 by the time she reached 35. If she never saves another penny for retirement, her IRA will be worth around $38,000 when she turns 65. Notice that Mark and Mary saved the same amount of money: $5,000. It was the delay in getting started and loss of 10 years of compounding returns that was the difference.
Join a Retirement Plan at Work
The best way for many 20-somethings to get started planning for retirement is to enroll in an employer-sponsored retirement plan, such as a 401(k). Many employers match a small percentage of your 401(k) contributions. This represents a guaranteed, no-risk return on investment.
Another advantage of participating in your employer’s retirement plan is that contributions are automatically deducted from pay and deposited into your account each pay period on a pre-tax basis, which lowers current income taxes.
If your employer doesn’t offer a 401(k), the next best option is to open an IRA. There are two main types of IRAs: traditional and Roth. With a traditional IRA, you can deduct contributions you make, which could lower your income taxes. The money is taxed when withdrawn, growing on a tax-deferred basis in the meantime.
With a Roth IRA, there’s no current tax deduction for contributions. However, withdrawals are made tax-free, which can help make your retirement nest egg last longer. And unlike traditional IRAs, contributions to Roth IRAs (but not earnings) can be withdrawn at any age penalty-free.
Get an Early Jump
Getting a jump on planning for retirement in your 20s could help you secure a more financially comfortable future down the road. The sooner you start saving for retirement, the more you could benefit from compounding of returns — and the bigger your retirement nest egg could be.
Disclaimer: The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice