If you’re in your 20s or 30s, it’s likely you haven’t given much thought to retirement savings. After all, the moment you leave your job for a lifestyle of kicking back at the beach or playing golf all day is decades away.
However, right now is exactly the time you should start saving. In fact, ideally, you should make your retirement money a priority starting with your first full-time job.
Why? Well, you’ve got something called compound interest working on your side. And over time, it can multiply your money many times over.
But how can you start maximizing your 401(k) if you’re in your 20s or 30s? Below are some steps you can take now to start making your dream retirement a reality… even if it’s 50 years away.
Step 1: Get Started Now
If your employer offers a 401(k) plan*, be sure that you contribute as soon as you are eligible. While you might not be able to contribute the full $18,000 per year that is allowed, pitch in as much as you can. This money will be invested for many years to come, and you will benefit from the magic of compounding interest.
If your plan offers an employer match, your initial goal should be to contribute at least enough to earn the full match. A common match is 3% if you contribute 6% of your salary. The 3% represents an immediate 50% return on your contributions — that’s hard to beat. And the match is free money to boot; never pass that up.
Some plans have a feature called “auto-escalation.” This will increase the percentage deferral from your salary automatically if you sign up for it, and you absolutely should. You will never miss a 1% or 2% increase in the amount you are contributing, and over time this can make a big difference in the amount you accumulate for retirement.
Step 2: Consider the Roth Option
More and more 401(k) plan sponsors now offer a Roth option in their plan. A Roth 401(k) works much like a Roth IRA in that contributions are made with after-tax contributions, and the money grows tax-free while in the account and can be withdrawn tax-free at retirement as long as certain requirements are met.
You can divide your contributions between the traditional 401(k) account (with pre-tax contributions) and Roth (with after-tax contributions). The advantages to a Roth when you are younger are that your income may still be on the low side and the tax benefits of the traditional 401(k) account are not worth as much to you. Note that any employer match will always be deposited into a traditional 401(k) account.
Step 3: Take Enough Risk
In your 20s and 30s, you still have a long time until retirement. While nobody likes to lose money, your long time horizon allows you take more risk than someone much closer to retirement. Your asset allocation should reflect this long time horizon until retirement. You have sufficient time to weather the market’s normal fluctuations.
For most in this age range, this means an asset allocation heavy in stocks for growth.
In your 20s you might consider using a target date fund or other type of managed portfolio option if your plan offers one. This is a way to invest in an instantly diversified portfolio right out of the gate.
By the time you reach your 30s you should have a bit more experience as an investor, and this is a good time to consider an allocation from among the other investment options offered in your plan. Going this route will allow you to better integrate your 401(k) account with the asset allocation on outside investments as well.
Step 4: Keep Your Expenses Low
No matter your age, it is important to keep your investing expenses as low as possible. Be sure to understand the expenses associated with your company’s 401(k) plan. Many plans will offer index funds, which are usually lower in cost than many other types of funds.
If the expenses in your company’s plan seem excessive, talk to your company’s benefits department about this and express your concerns. Obviously, you will want to do this in a polite, constructive tone.
Step 5: Manage Old 401(k)s
Most of you in your 20s and 30s will switch jobs several times before your finally retire. This means that you will need to decide what to do with the balance in your plan when changing jobs. Your choices are:
- Leave the money in your old employer’s plan. A good option if the plan offers solid, low-cost investment choices. If you have less than $5,000 in your account, be aware that your employer might distribute the money, triggering a potential unwanted taxable event. Be sure to check with your company as to your options.
- Roll the money over to a new employer’s plan if applicable and if they will accept the rollover. This can be a good choice if the new plan is a solid one. This will consolidate your 401(k) money, giving you one less retirement account to be concerned with.
- Roll over to an IRA account. This option can provide a wide array of choices, and an IRA can be a good way to consolidate several old retirement accounts in one place.
- Take a distribution. This will trigger taxes and a 10% penalty (unless you are older than 59½ or qualify for one of several exceptions to the penalty). This is generally a bad idea in that this is an expensive source of money, and you lose the benefit of tax-deferred compounding for your retirement.
Step 6: Avoid 401(k) Loans
Many 401(k) plans offer loans from your account. While it is nice to have this flexibility, this money is for retirement. A Fidelity study indicated that those who take an initial loan are likely to take another one, and so on.
If you end up leaving your job before that loan is repaid, this might trigger a requirement to make repayment within 60–90 days. If you can’t repay the entire amount, this will trigger income taxes and the 10% penalty.
Step 7: Figure Out How Much You Should Save
There is no right answer, but T. Rowe Price offers this guidance:
- By the time you are 30 you should have one-half of your annual salary accumulated for retirement. If you earn $60,000, this means that you should have $30,000 saved.
- By age 35 this increases to one times your salary saved for retirement. If you are earning $70,000, this is the amount you ideally should have accumulated for retirement by this time.
- By age 40 the amount is two times your salary. A 40-year-old earning $80,000 should have $160,000 saved for retirement.
These are just guidelines, but if you aren’t at least on track toward these levels, there is no better time to get started making the most of your 401(k) plan than today.
* Depending upon where you work and your occupation, your retirement plan could also be a 403(b), which is common for teachers and those working for a non-profit, or a 457 plan, which is common for governmental and municipal employees. While there are some differences in these plans versus a 401(k), the basics of contributing and investing for retirement are quite similar, and the tips discussed here mostly apply to these plans as well.