I never thought about how to start saving for retirement when I was 20. Whenever someone tried to talk to me about retirement funds, my mind would drift to picturing the teacher in Charlie Brown.
Wah wah woh, wah wah
Who cares about how to start saving for retirement when you’re as young as 20 and just starting your career? When living month-to-month, it seems like contributing to retirement plans falls behind everything else including the few dollars left that could go towards eating out a few times with friends or online shopping.
All of a sudden, you have a job and have no idea how to budget and finance. I get it. It’s a lot and there isn’t a manual that just tells you how you should manage your money.
Here are some of the basics:
1. Pay off your debt as soon as you can.
There are a few exceptions to this rule. But unless you are financially savvy and able to play the stock market to make more money than the interest on your loans, you need to pay off your debt as soon as possible. After graduating, you see your classmates going out and living in fancy apartments. Do NOT try to live outside of your means. Keep living like a student until your debt is gone and you can be comfortable. The interest from your loans will accumulate over time. A $10,000 in a college loan can easily double or triple by the time you can pay it off later in life unless you get the debt taken care of early. You will be doing yourself a huge favor. (If you’re looking for some advice on paying them off, read this article).
2. Save money each month for an emergency fund.
You want to make sure you have enough money in your account to be able to pay for 3 months of expenses. This is your “do not touch unless it in an emergency” money. On the off-chance that everything goes wrong, you want to have an emergency buffer to land on to prevent yourself from ruining your credit and ending up farther in debt. Live frugally early to build some money reserve. You’ll be able to breathe easier and know that you have money for a rainy day.
3. Start putting money into your retirement account asap.
A retirement fund is a way for you to grow your money. Starting early gives your money a chance to earn more over time and have the most potential. Any extra money that you can put into a retirement account will leave you very comfortable later in life.
Millionaires don’t live like millionaires. Most people who make good money are smart about how they invest and can grow their money over time while living well within their means. One of the smartest decisions that you can make early in your career is to invest your money into a retirement account so that you can grow your money.
So how do you know what retirement account is good for you?
Based on your employer, you will likely have options for retirement plans. There are two main categories of retirement plans: pre-tax accounts and post-tax accounts.
Pre-tax retirement accounts
A pre-tax retirement account means that the money you put into the account is not taxed now. Instead it will be taxed when you take it out of the retirement account.
If you are early in your career and have about 30 years before you will be taking money out of your retirement account, consider the amount of money that will be growing and whether you will then fall in a higher tax bracket and have to pay more money later on. If you have a job where you make minimum wage now and will likely be making a lot more money later in life, then this plan may not be right for you since you will have higher taxes later in life than you currently have.
However, if you are making lots of money now and think you may be working part-time or switching to a lower-paying job later in life, then this plan may be beneficial since you will have less tax to pay now and then will be in a lower tax bracket when you withdraw the money.
Post-tax retirement accounts
A post-tax retirement account means that the money you put into the account will be taxed before it is entered and then will not be taxed when you take it out during retirement.
The term “Roth” may be used to tell you that an account is post-tax like a Roth IRA or Roth 401(k). A post-tax account is beneficial for the majority of people who are just starting their careers. If you are making a lower amount of money early in your career, you will fall in a lower tax bracket than you will later in your life (hopefully. It makes financial sense to pay your taxes on your retirement money then put it into your retirement account and watch it multiply without needing to pay taxes on it later in life.
Putting money into the post-tax retirement account means that you will feel more strapped for cash in the short-term. But, the dividends are worth the price if you can afford it because you end up paying much less overall.
Okay, so now that we understand the basics, let’s jump into which account is right for you. This a very important step as you start saving for retirement at 20. There are a lot of different account types including 401(k), 203(b), IRA, 403(b), etc. Let’s break this down into the need to know information and how you should approach picking your plan.
First, look at the retirement plans available through your employer. An employer retirement account could be a 401(k), 403(b), 203(b), etc. Don’t worry about the numbers.
Instead, look at whether the account is pre-tax or post-tax. Remember, if the account has the term “Roth” before it, then it is a post-tax account.
Then, look at if the employer will give you a “match”. Some companies will incentivize you for putting money into your retirement account because they want you to save money and stay at the company. Your employer may say that for every 10% of your income that they put into your retirement account, they will also put in 10%. Great! Why not have your company pay you more money to do the same work?
A caveat to the match amount is that you want to look at whether the employer contribution is “vested”. This sounds complicated, but hear me out.
Investing involves putting money into something to see if it can turn a profit. When thinking of “vesting” consider that a company wants you to stay with them. They may say “we’ll match the money you put into your retirement account but we’ll give it to you slowly”. The money then becomes yours or “vests” over a certain period.
For example, the terms could say ‘30% vested in 3 years; 60% vested in 4 years; 100% vested in 5 years.’
This would mean that you would get 30% of the matched retirement money if you stay at the job for 3 years, and would get all of the matched retirement money if you stay for 5 years. Some companies will give you the money immediately without caveat and say “immediately vests” which is wonderful, but it is worth checking the terms of the account match.
So what if your company doesn’t match retirement funds? or doesn’t offer a good retirement plan option?
You can open your retirement account like an IRA or Roth IRA. If you are early in your career and making a modest salary, you should look into opening a Roth IRA. The Roth IRA has a contribution limit of $6,000 a year and is post-tax. It means that any money you put into the account will grow without needing to be taxed. The best time to start a Roth IRA will be just out of college when your money has the most potential to grow. You can earn on average 7% each year on Roth IRA growth. This is much higher than the average savings account interest rate.
We don’t think about retirement plans as a way to invest our money. But they are a great way to build your money. If you start early and put money away each month, you can quickly find yourself building your wealth and set yourself up for a comfortable future.
Hopefully, this quick guide will provide some guidance as you navigate your finances and figure out what retirement plan is right for you. With these tools, you can start saving for your retirement at 20, or in your 20s.