If you're in your 20s, retirement may be the last thing on your mind. Between navigating your student loan payments and learning how to live and budget on your own, it's not surprising that for many 20-somethings, retirement takes a backseat to other financial goals. In fact, according to Moneyunder30.com, in 2015, only 46% of Americans in their 20s contributed to a retirement account. But in reality, your 20s are the perfect time to start saving for retirement. Now you may be wondering: How much do I need to save for retirement? Should I open an IRA or put money into a 401(k)? If you want to begin planning for the future but don't know how to start, read on to discover some of the best ways to save for retirement.
When to start saving
First, let's get one thing straight: While saving for retirement is extremely important, your first goal should be to amass an emergency fund to cover three to six months' worth of living expenses. This will serve as your go-to money in the event that you encounter an unexpected expense or are unable to work for a period of time. Once you've saved enough to fund your emergency account, your next goal should be to eliminate outstanding credit card debt. Not only will carrying a balance impact your credit, but the longer you do, the more money you'll wind up wasting on interest charges. But as soon as you pay off that nagging balance, it's time to start saving for retirement. There's no such thing as being too young -- the more time you give yourself to save, the more opportunities your money will have to grow.
How much to save
Most people wonder how much money they'll ultimately need in retirement, and the answer is: as much as possible. There's no single magic number that guarantees a financially secure retirement. There are different factors, such as your health and lifestyle choices, that dictate how much you'll eventually come to need, and as a 20-something, you may not have all of your retirement goals mapped out. That's why your initial strategy should be to save as much as you can, as early as you can -- whatever that amount happens to be. Saving 10% or more of each paycheck would constitute a strong start, but if you can't swing that amount, know that every little bit counts. The key is to save consistently and ramp up your savings over time as your salary increases.
Choosing a retirement account
Most people who save for retirement choose between a 401(k) plan and an IRA. If your employer offers a 401(k), signing up might be the easiest way to stick to your savings goals. With a 401(k), you can allocate a portion of your paycheck to go in automatically, which will help you avoid the temptation to spend that money elsewhere. You can currently contribute up to $18,000 a year to a 401(k), and whatever amount you designate goes in on a pre-tax basis. It also pays to see whether your company offers a 401(k) match. If it does, be sure to contribute enough to maximize that benefit.
If your company doesn't offer a 401(k), or if you don't like your company's plan, you can look into opening an IRA. With a traditional IRA, the money you contribute goes in pre-tax, whereas Roth IRAs are funded with after-tax dollars. If you're single and earn less than $132,000, you're eligible to contribute to a Roth. The current contribution limit for either option is $5,500 a year.
If you happen to be self-employed, there are other options to look into, like a solo 401(k) or SEP or SIMPLE IRA. SEP and SIMPLE IRAs work much like traditional IRAs but come with higher annual contribution limits.
Investing your savings
Once you've opened a retirement account and committed to parting with a portion of your paycheck, your next step is deciding how to invest your savings. One major benefit of being in your 20s is that you have decades to ride out the stock market's ups and downs, and because stocks have historically delivered higher returns than bonds, they're generally the best option for younger investors. If you start saving $200 a month at age 25, invest that money heavily in stocks, and generate an average annual 8% return, by the time you reach 67, you'll have $730,000 to your name. While there are safer investments out there, like bonds, they typically deliver much lower returns, which can hamper your savings long term.
Saving for retirement in your 20s can pave the way for a financially secure future. It may not be the most fun thing to do with your extra money, but it's by far the most responsible.