Young professionals might feel like retirement is not their first financial priority, but starting to save and invest early means you can earn more over time and unlock a more comfortable retirement. Plus, building retirement into your financial plan when you are just getting started makes it easier to establish the habit.
“Having a financial plan when you’re young provides direction and sets clear goals for your future, helps you develop good financial habits, build security, manage debt, make informed decisions and seize opportunities for financial growth. It’s a valuable tool for establishing a strong foundation and ensuring a stable and successful financial future,” says Nick Coleman, certified financial planner with Bonfire Financial.
Follow these tips to get ahead on retirement planning while you’re still in your 20s.
- Start early.
- Build an emergency fund first.
- Find a job with retirement benefits.
- Choose the right retirement account.
- Save automatically.
- Don’t pass up a 401(k) match.
- Make strategic investments.
- Roll over your savings.
- Claim the saver’s credit.
- Avoid accumulating debt.
One of the most important rules of retirement planning is to start early so you can take advantage of compounding interest.
“The power of compounding interest means that the earlier you start saving, the more your money will grow over time. Even if you can only afford to save a small amount each month, starting early can make a big difference in the long run,” says Erik Weir, principal of WCM Global Wealth.
That’s why it’s critical to prioritize retirement savings even in your early 20s – or as soon as your budget allows.
Build an Emergency Fund First
Even though saving for retirement early is beneficial, it’s not necessarily the first financial goal you need to reach. Experts recommend ensuring you have a sufficient emergency fund before redirecting any savings.
“First, young professionals should cover their bases by making sure they have enough money saved in the bank to cover six months of expenses. This is critical because it lays the foundation for a good personal balance sheet. Without sufficient cash available, people can run into issues if an emergency occurs or if they want to take advantage of an opportunity like buying a new car or house” Coleman says.
Find a Job With Retirement Benefits
Remember to factor a retirement plan into your career decisions. A 401(k) match or other employer contributions are likely to be the best return you will ever get on an investment, and they can easily boost your money over a short period of time.
Also, pay attention to when you vest in your retirement benefits. While some job opportunities are too good to pass up, consider sticking around until you get to keep your employer’s contributions to your retirement plan.
Choose the Right Retirement Account
From 401(k)s to 403(b)s and IRAs, there are lots of different kinds of retirement accounts with their own tax benefits and contribution limits. Understanding which options are available to you and their pros and cons can help you ensure you are putting your money in the most effective account.
“Consider tax-free first and pretax second,” advises Kelly Gilbert, fiduciary investment advisor at EFG Financial. “A Roth IRA uses after-tax funds. This means taxes are already paid, so the account can grow tax-free. Additionally, during retirement, the funds can be withdrawn tax-free too. This substantially reduces your tax risks during retirement, enabling your savings to last longer.”
“Unless your employer provides pretax 401(k) matching, it is always smarter to invest in after-tax Roth IRAs first, and only invest in pretax accounts after your Roth IRAs are fully funded,” he adds.
Have a small amount withheld from your paycheck and deposited into your 401(k) plan. This automation can help ensure you’re tucking away a bit of your income every month and your nest egg will begin to build over time.
If your job doesn’t offer a 401(k) plan, you can set up a direct deposit to an IRA, Roth IRA or even a savings or investment account.
Don’t Pass Up a 401(k) Match
Aside from the tax benefits of various retirement accounts, a 401(k) match from an employer is essentially free money. Investing enough to take advantage of the full match amount is critical.
“It is important to get the most out of your company’s retirement plan. Many companies offer a 401(k) or other retirement plan, and many of those companies will match what you put into the 401(k). Taking advantage of your company match will help you save more for your retirement and also take advantage of the ‘free money’ your company is offering you,’” says Coleman.
Make Strategic Investments
As a younger investor, you have the ability to make more risky investments than someone who is retiring in five years. Still, choosing the right mix of investments to balance risk and return is important.
“When investing your retirement savings, consider low-cost index funds instead of individual stocks or high-fee mutual funds. These funds offer a diversified portfolio at a low cost, which can help maximize returns and minimize risk,” says Weir.
Roll Over Your Savings
When you change jobs, consider rolling your savings over to an IRA or your new employer’s 401(k) plan. A trustee-to-trustee transfer between the accounts will allow you to avoid taxes and penalties on the transaction. If you withdraw your savings from the account you will need to pay income tax and a 10% early withdrawal penalty on the amount you withdraw.
Claim the Saver’s Credit
If you have a small salary but manage to save something for retirement, you might qualify for the saver’s credit. Individuals whose adjusted gross income is $36,500 or less in 2023 can claim a tax credit worth between 10% and 50% of the amount contributed to a retirement account up to $2,000 for individuals. The saver’s credit can be claimed in addition to the tax deduction for saving in a 401(k) or IRA.
Avoid Accumulating Debt
Although experts agree that young professionals in their 20s should prioritize retirement planning if they can, avoiding establishing bad financial habits or getting into debt should always come first when ensuring your future financial wellness.
“Be mindful of your spending and avoid accumulating unnecessary debt. The less debt you have, the more money you can direct towards retirement savings,” says Weir.
Coleman adds that it is easy to get sucked into credit card debt by carrying a balance, thanks to high interest rates. He recommends getting used to consistently paying cards off.