To the young, it might seem crazy to create an article that talks about retirement planning in your 20s. Admittedly, to most 20-somethings, retirement is so far away that it occupies very little of their thoughts. But the reality is a time will come when these "youngsters" will retire too.
In fact, anyone in their 20s might have some fairly unique qualities that make retirement planning important, including:
Today, there are three important tools the government, or an employer, supplies to help produce income in retirement. These tools include pension plans, Social Security, and retirement accounts / plans.
For many individuals in their 20s, two of these income producing plans might not be around or nearly as generous as expected. Admittedly, there could be a program that appears to replace Social Security or Social Security itself may actually survive. But right now there is only one reliable planning tool to supply income: retirement savings accounts.
Enough of the bad news, it's time for some good news. Perhaps the most powerful factor that workers in their 20s have over those that are nearer to their retirement days is time.
Twenty year olds have 30 to 40 years before retirement, and that is a huge advantage over many older workers. With that much time to save money, the magic of compounding interest is on their side. To demonstrate the power of time, let's look at two examples created using our retirement savings calculator.
|Desired Retirement Age||65||65|
|Annual Household Income||$50,000||$80,000|
|Anticipated Income Growth Rate||3.0%||3.0%|
|Desired Income Replacement Rate||70%||70%|
|Current Retirement Assets||$4,000||$4,000|
|Expected Return on Investments||6.0%||6.0%|
|Expected Pension at Retirement||$33,000||$33,000|
|Social Security at Retirement||$0||$30,000|
|Ongoing Annual Savings Required||$5,750||$10,125|
Some very reasonable assumptions were used in this example to demonstrate this point. The above retirement savings example demonstrates that even without the benefit of Social Security, a 25-year-old would need to save roughly half the amount that a 55-year-old would each year into a retirement account to reach their income target.
We've mentioned retirement savings accounts several times already in this article, without explaining exactly what is meant. By eliminating pensions and Social Security from the picture, there are only a couple of options.
Even if someone job-hops throughout their career, and they don't accrue a significant pension, they can still participate in employer sponsored retirement savings plans such as a 401(k) and 403(b) plan.
The amount an individual can contribute to each of these plans is relatively generous, and often involves an extremely valuable employer match. If an employer offers such a plan, this is usually the best savings option.
An alternative is to fund an Individual Retirement Account such as a Roth or a Traditional IRA. In fact, for individuals in their 20s, an IRA may be all that is needed to fund their retirement savings plans; if they start saving early. That's because the IRA contribution limits are relatively generous for anyone that can make 30 to 40 more annual payments into these types of plans.
For anyone in their 20s, retirement may seem so far out in time that it's hard to imagine that planning is even necessary. They may be preoccupied with paying off student loans if they went to college. Individuals thinking about getting married may be worried about paying for a wedding. First time home buyers now find themselves with a new mortgage payment to make each month.
The point of this article is that starting slowly at this young age can make a big difference later on. Even a small contribution to an IRA will pay dividends in the future. So what exactly are the retirement planning strategies that anyone in their 20s can adopt?
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