It’s easy to understand why saving for retirement isn’t a priority in your 20s — a decade when advancing your career, not planning for the end of it, seems more important.
But youth is a huge advantage when it comes to building wealth for retirement because it gives you time to maximize the power of compound interest. With compounding, you can save a little now and reap big rewards later.
And in your 20s, you may not have a mortgage to pay or a family to support, so saving is easier. Don’t pass up the opportunity to get a jump-start on saving for retirement.
Here are five tips for maximizing retirement savings in your 20s.
1. Start saving today
You can probably find plenty of reasons not to save money. Funding a 401(k) seems impossible if you’re struggling to pay off student loans or cover your rent.
But letting expenses become an excuse is a mistake. The longer you put off saving, the more it will set you back in the long run. Take a close look at your budget and look for areas where you can cut your spending. Try to save at least 10 percent of your income.
Check out these tips for saving more money.
2. Sign up for your employer’s 401(k)
If you’re eligible to participate in a 401(k) at work, do so. Some employers match your contributions to encourage your participation.
When you sign up, the money you save is automatically deposited into the plan before it’s taxed, so less of your income will be taxed now. In effect, the government is giving you a tax break today to save for retirement.
Plus, you’ll get another serious advantage. The 401(k) allows your savings to grow tax-free until you withdraw the money at retirement. This feature means your money will compound at a faster rate. Only when you withdraw money will you pay taxes.
And there’s an even more powerful way to increase your returns. Contribute as much as you can and try to take full advantage of your employer’s matching contribution. For example, if your employer contributes $1 for every $1 you save, up to 6 percent of your pay, do your best to contribute 6 percent. That’s a 100 percent immediate return on your saved money – plus you’re saving on taxes, too!
But don’t leave yourself strapped for cash. In 2020, the maximum pre-tax annual contribution is $19,500.
3. No 401(k)? Open a Roth IRA
If you aren’t eligible for a retirement fund at work that gets you matching funds, sign up for a Roth IRA. You’ll fund it with money out of your paycheck that’s already been taxed, but when you withdraw the money in retirement, it will be tax-free.
While a Roth IRA won’t save you money on taxes this year, it’s a fantastic way to avoid paying taxes on your future investment earnings. This benefit might be the most important, but the Roth IRA has a number of other powerful features that make it a top account for those looking to amass wealth.
In 2020, you can put up to $6,000 in a Roth as long as your income doesn’t exceed a certain amount. If you can’t save the max, save what you can; it will add up. To make sure you stick to saving, have a portion of your paycheck automatically deposited into the Roth on a regular basis.
4. Be aggressive with your investments
Put a high percentage of your portfolio in stocks. While stocks are one of the most volatile types of investments, they also have a great long-term track record, too. So the more you can invest in them, the more wealth you should be able to amass. When you’re in your 20s, you have a long investment horizon, so it should be easier to handle the ups and downs of the market.
Check out this asset allocation calculator to create a balanced portfolio of investments that fits your time horizon and risk tolerance. As you get older and closer to retirement, you can move more of your assets into less volatile investments, such as bonds.
Instead of picking individual stocks, look to mutual funds or exchange-traded funds, or even a target-date fund, to diversify your investment portfolio.
5. Build an emergency fund
Start building an emergency fund so you don’t have to rely on credit cards, or worse, your retirement savings, for unexpected expenses such as a car repair. Ideally, you’ll want to save up to six months’ worth of living expenses.
Set up automatic deposits to a high-yield savings account to stay on track. Having emergency cash in an easily accessible savings or money market account could keep you from dipping into your retirement funds if your car breaks down or you suddenly need a new iPhone. If you withdraw money from a retirement account too soon, you’ll be taxed heavily.
- How to save for retirement when you’re in your 30s
- 5 reasons you should never take out a 401(k) loan
- How to buy stocks
— Bankrate’s James Royal contributed to the update of this story.