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Retirement Planning in your 20s

| March 13, 2018
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Retirement is an important goal that all of us have in common. No matter what age, this is an achievement after decades in the labor force.

That said, planning for retirement comes with different goals and different challenges. For people in their 20s, you are either just out of college or have just entered the workforce, and retirement seems so far away.

Here are tips on how to plan for retirement while in your 20s.

Start Now

You have a very distinct advantage compared to other age groups, time. You need to start planning and saving for retirement as soon as possible. The earlier you start, the more time you give your money to work for you.

The gem in finance and investing is compound interest or compound returns, and I will illustrate just how powerful it is with an example.

You have person A who is 25 and starts their retirement account $10,000 and contributes $100 per month. Person B also starts their retirement account $10,000 and contributes $100 per month, but they start 10 years later at 35. Person A after 40 years of saving, assuming an annual return of 7% will start retirement with $398,300. Person B, assuming the same interest rate, will start retirement with $193,730.

The difference in the amount they contributed was only $12,000, so the essentially $200,000 difference came almost entirely from interest.

Create a budget

Step two is to create a budget. I have written about this before so I will link to a post on how to create one here.

Emergency fund

An emergency fund is important because it keeps your regular budget from derailing. If you don't have one, start one now. If you do have one, consider increasing the amount you save each month by a few dollars. Rule of thumb is to have 3-6 months worth of expenses saved in your emergency fund.

Employer-sponsored retirement

If the organization you work for offers one, contribute to a retirement plan. More often than not it will be a 401(k), but sometimes, in the instance of a small business, it could be a SIMPLE IRA. Both come with their unique characteristics, but in either case, you should contribute enough to at least receive the company match.

A company will usually match up to a certain percentage of your salary. For example, you contribute 10% of your salary and the company will match you dollar for dollar up to 5%. If you make $5,000 monthly, your contribution will be $500, and your employer will contribute $250 on your behalf.

Roth IRA

If you contributed to your company's retirement plan or contributed to an IRA because you weren't offered a plan through work, it's time to open a Roth IRA. Only open this if you contributed enough to receive the match through your employer.

A Roth is advantageous because it offers retirement income on a tax-free basis. Contribute regularly to this so you have income in retirement that isn't taxable to offset the taxable income you receive from your employer retirement plan.

Increase Savings

Do what you can to increase the amount you save for your retirement accounts and your emergency fund. If money is tight, consider a few more dollars each month for your emergency fund, and increase your contribution percentage 1% for your retirement account. After a few months or more, if you've gotten used to working with less income, consider another bump up.

The ideal savings rate for retirement is 15% of your income. If you can't do that much, just do as much as you can. If you can do more, by all means, do more.

Pay off debts

Come up with a debt repayment plan. If you have a lot of student loans, shop around and see if you can save money with a lower interest rate somewhere else. Another option is to work in the public sector for at least 10 years, while you pay off your debt. After the 10th year, you may be eligible to have the rest of your debt forgiven.

If you have a lot of credit card debt. Consider a balance transfer to an interest-free card, or take out a personal loan with an interest rate much lower than that of your credit card(s).

When paying off credit card debt, without using either of the options above, there are generally two repayment methods:

1. Snowball method - Using this method, you pay off the card with the smallest balance first. Pay the minimum on all of your remaining cards and put everything you can toward the smallest balance. Once you pay that off, take the money that you were using for it and put it towards the next smallest balance.

2. Avalanche method - This method has you pay off the card with the highest interest rate first. Similar to the snowball method, pay the minimum to all the other cards. Pay as much as you can towards the card with the highest interest rate. Once that is paid off, put that money towards the card with the next highest interest rate.

Automate

Set everything you can to auto-pay, auto-transfer, or auto-save. When you have bills on auto-pay, you negate the chance of forgetting to pay, and incurring late charges or damaging your credit score.

Having your retirement and emergency fund saving automated, essentially ensures that you will save for those things first before you blow your money on nights out and other things you don't need.

Conclusion

Saving for retirement is super important. It is a goal we all strive for, but there are certain challenges that come with each age group. With the twenty-somethings, the advantage is time, but the challenge is usually loads of debt. Using these tips, I hope you are able to make immense progress towards your retirement savings goal.

Note: The material in the post is for informational purposes only. Please consult with a financial professional about your personal financial situation. Do not make decisions based solely on what you read or hear.

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