Retirement Savings Tips by Age- In your 20s

The savings and investment decisions you make in the decades leading up to your retirement can have a big impact on your financial security in retirement. The following retirement savings tips are designed to help you make informed decisions. Of course, the tips are general in nature, so please seek personalized retirement planning advice from us regarding your specific situation.

Start saving now. One of the smartest financial moves you can make in your twenties is to begin saving for your retirement. Why’s that? The longer the earnings on your investments have to compound-that is potentially generate earnings themselves- the less income you may need to contribute to reach your savings goal. 

To illustrate this point, let’s look at two hypothetical investors: Jake and Alexa. Each contribute $10,000 a year to a tax-deferred retirement plan for 10 years and earns 6% annually, but Jake contributes from age 25 to 35 and Alexa contributes from age 35 to 45.

Despite contributing the same overall amount ($100,000) and earning the same annual rate, at age 65, Jake’s savings amount to about $757,000 and Alexa’s to about $423,000. Why the big difference? Jake’s savings had an extra 10 years to compound.

Could Alexa have saved $757,000 by age 65? Potentially, yes. But because she started later than Jake, she’d need to contribute considerably more than Jake each year to reach the same savings goal by age 65. (This is a hypothetical example for illustrative purposes; your results will vary.)

Contribute to the retirement plan at work. If your employer offers a retirement plan, take advantage of it. Here are a few reasons why.

The tax benefits. Many retirement plans are tax-deferred, meaning that income tax is deferred on your contributions and investment earnings until you withdraw them from the retirement account. This tax deferral can benefit you in two ways.

First, your contributions reduce your current income taxes. For example, if you contribute $10,000 to a tax-deferred retirement plan this year, you will not have to pay income tax on that $10,000 this year. If you are in, let’s say the 25% federal income tax bracket, a $10,000 contribution will trim your current federal tax bill by $2,500, which may make it easier for you to afford to contribute to your retirement savings.

Second, your investment earnings are not taxed while in the account, which can help your savings grow faster than if they were in a taxable account where earnings are generally taxed every year. Some types of retirement plans, such as 401(k) and 403(b) plans, may also offer Roth accounts. Unlike tax-deferred accounts, contributions to Roth accounts are made from income that has already been taxed, but both your contributions and earnings can be withdrawn tax-free in retirement.

Employer match. Some employers may match a portion of the money you contribute to its retirement plan. For example, an employer may match your contributions, dollar-for-dollar, up to 6% of your pay. If your employer offers a match, it is generally a good idea to take them up on their offer. Over time, the matching contributions that your employer makes to your account can significantly boost your retirement savings.

Convenience. When you enroll in a retirement plan at work, you’ll generally choose how much of your pay you want to contribute and how you want your contributions invested. Your employer and the financial company that holds your account will take care of getting your contributions where you want them to go. This automation helps ensure that your contributions are made on schedule without you lifting a finger. Of course, you’ll still need to review your account periodically to see if there are any changes you want to make.

Consider opening an individual retirement account (IRA). An IRA is a type of retirement account that you can open and contribute to on your own- even if you already contribute to a retirement plan at work. And like workplace retirement plans, IRAs offer tax benefits.

The traditional IRA offers tax benefits that you can take advantage of right away. Your contributions may be tax-deductible and your earnings grow tax-deferred. Your deductible contributions and your earnings will eventually be subject to income tax, but not until you withdraw them from the IRA.

The Roth IRA offers future tax benefits. Contributions are not deductible, but you can withdraw them tax-free at any time. Plus, earnings grow tax-free in a Roth IRA and can be withdrawn tax-free in retirement. 

If you are in your twenties, a Roth IRA may be an especially good fit. This type of IRA tends to be well-suited for individuals who expect to be in a higher tax bracket in retirement than they are now, which may be the case for you if you are just starting out in your career. Although you will not receive a tax deduction for the money you contribute to a Roth IRA, you will avoid income tax on your withdrawals in retirement when you may be in a higher tax bracket, which may be more advantageous.

Invest for growth. The younger you are, the more stocks you may want to hold. The reason? Stocks offer greater growth potential over the long term than bonds or cash investments. And although stocks are also more volatile, meaning their prices tend to move up and down more dramatically, investors with decades to go before they will need their money may have time to ride out market downturns and benefit from stock’s greater growth potential.

In addition to saving for retirement, it’s also a good idea to save for emergencies by stashing enough cash in an interest-bearing account to cover at least 3 months of living expenses. Having a pool of cash to draw on in an emergency, such as job loss, can help you deal with an emergency without having to dip into your retirement savings.

You may also want to consider funding health savings account (HSA). If you have a high-deductible health plan, consider opening an HAS and using it to save for your medical expenses in retirement. HSAs offer three tax advantages, which may help your savings grow faster than in other accounts.

1. Your contributions are tax-deductible or made with pre-tax dollars.
2. Earnings growth is tax-free.
3. Withdrawals for qualified medical expenses are tax-free.

Please consult us for advice on your future retirement planning.

For more retirement savings tips, visit our other blog posts:

Retirement Savings Tips by Age- In your 30s and 40s 

Retirement Savings Tips by Age- In your 50s 

Retirement Savings Tips by Age- In your 60s

With offices in Rutland and Williston, Vermont Copper Leaf Financial develops a customized wealth management plan designed to integrate every aspect of your financial life. Our approach is to conduct business in an orderly fashion, especially in a disorderly world. Where there is uncertainty we look for facts. We call our approach evidence-based investing. Call us today at 802.878.2731 to schedule a strategy session and begin building your road map to financial success.

Article published in April 2020 edition of Eye on Money. If you would like to be added to our mail list please email jennifer@dh-cpa.com.