Starting to Plan For Retirement in Your 20s

Who needs to worry about retirement when you're in your 20s? You do! It's never too early to start planning for your golden years.

Financial security during your retirement is something you should start planning for right now. Modern medicine continues to extend our average life expectancy. This means that, if you plan to retire in your mid- to late-60s, you should be thinking about preparing a retirement plan that will cover your living expenses for at least 20 years. Carefully designing a savings approach now will ensure you a comfortable retirement. Don't forget that retirement planning is just one element of a comprehensive financial plan. You'll want to balance your retirement planning against other important financial objectives, such as saving, budgeting, insurance, and getting out of debt. So, you have somewhere between 35 and 45 years to plan and save for retirement. Sound like a long time? Well, it isn't really, and the sooner you start, the easier it will be. Since you have plenty of time, you won't have to sock away very much each month to ensure yourself plenty of money for your retirement years.

Where Does the Money Come From?

Three commonly available sources of retirement income are:

1. Private savings or investments, including Individual Retirement Accounts (IRAs)

2. Employer-sponsored retirement plans, such as pensions, 401(k)s, Keogh plans, SEP-IRAs, or SIMPLE IRAs

3. Social security benefits

There is an additional source of retirement income — working after you reach retirement age. And while you may decide to continue working during your retirement years, you may want to start your retirement plan now so you won't have to rely on this income.

Private Savings or Investments

Creating this portion of your retirement income is entirely within your control. Many financial advisors agree that you should save approximately 10% of your income annually. Some of this should be set aside for emergencies and the rest should be earmarked for retirement.

For your retirement, consider taking advantage of tax-deferred investments. Tax-deferred means you don't pay taxes on your investment earnings until you use the funds. You can invest in an IRA to maximize your rate of return. You might even be able to deduct your IRA contributions on your taxes. Check with a financial professional or the Internal Revenue Service (IRS) to determine if you qualify for a tax deduction. Don't forget that IRAs are specifically designed as investments for retirement, and you may pay a substantial penalty for early withdrawal. See IRSPublication 590: Individual Retirement Arrangements.

Employer-Sponsored Retirement Plans

If you are eligible to participate in your employer-sponsored 401(k), take full advantage of this savings opportunity. Even though retirement seems a long time away, starting now will make it easier to reach your goal of a comfortable retirement.

The contributions you make to a 401(k) plan are tax-deferred. This means they are deducted from your pay before taxes are assessed. For example, assume you are in a 20% tax bracket, and you are thinking about investing $50 of every paycheck into a 401(k). If you were not investing in the 401(k), that $50 (considered part of your income) would be taxed at 20% and you would only receive $40 (20% = $10, subtracted from $50). However, if you put the $50 into a 401(k), it is not considered part of your income for tax purposes (and lower income means lower tax). Even better, you earn tax-deferred interest on your investment in the retirement plan.

If your employer matches your contribution, you've got a windfall! You'll need to decide how important that portion of your paycheck is to your budget before deciding how much to invest in a 401(k). Don't forget that 401(k)s are specifically retirement investments, and you may pay a substantial penalty for early withdrawal. Careful planning is important to ensure the right balance between savings and retirement investments.

For more information about 401(k) retirement plans, read the Federal Citizen Information Center article Life Advice About 401(k) Plans and the related articles in our Knowledge Center Library.

If you currently work, or previously worked for a company that provides an employer-paid pension, that's great news. A pension is a retirement plan entirely paid for by your employer. You may want to check with the benefits administrator and ask for an estimate of how much you will receive once you finally retire. Don't forget to periodically check the financial condition of previous employers that owe you a pension to make sure it's still a reliable source of retirement income.

Social Security

The Social Security Administration (SSA) provides free estimates of your projected retirement benefits based on your historical income to date and the number of years you have worked. In order to prepare a comprehensive game plan for a comfortable retirement, you can complete a Request for Social Security Statement. You can request your personalized estimate by either calling toll-free at 1-800-772-1213; writing to the Social Security Administration at 8515-A Liberty Road, Randalstown, MD 21133; or by visiting the SSA webpage at www.ssa.gov.See the Social Security Statement page for more information.

You've probably heard that many people believe the social security system will become defunct before you are eligible to receive benefits. While this is always possible, it is more likely that reform will be adopted, and even young workers will be able to rely on social security as a part of their retirement income. Nevertheless, you will not be eligible for full benefits before your 67th birthday. Estimate your future social security benefits cautiously when doing your retirement planning, since there will, most likely, be changes to the current system. To learn more about social security benefits and penalties, use the SSA Retirement Planner.

How Much Do You Need?

Many financial advisors agree that, to maintain the standard of living you have become accustomed to, you should plan on needing roughly 80% of your annual working pay during retirement. Remember, your retirement funds can come from any or all of the sources discussed. To illustrate, let's say you earn $65,000 during the year just before you retire. You'll need to plan on having $52,000 ($65,000 x 80%) each year during retirement to live comfortably and in the general style to which you have become accustomed. Let's take this one step further. If you plan on a long retirement of 20 years, you'll need $1,040,000 ($52,000 x 20). This is a very simplistic approach, since it doesn't allow for potential investment earnings or the effect of inflation on your buying power. But it will give you a general guideline of how much your expenses may be during your retirement.

How Do You Get There?

You are responsible for investing your private savings and your 401(k) funds to maximize return, growth, and income. When you are in your 20s, you can generally withstand more risk and greater fluctuations in your investment choices. While many financial advisors subscribe to some general investment strategies for young people planning their retirement, you should consider your personal financial situation carefully and may want to consult with a financial professional. The most important evaluation criteria you need to consider is your own financial condition and your risk tolerance. As a general rule, you may want to consider keeping as much as 80% of your investments in stocks and the other 20% in bonds and other fixed-income investments. This approach may allow you to grow your nest egg at a potentially higher rate. The flip side is that it assumes a higher risk tolerance, but the number of years you have to save for retirement will balance the market fluctuations. Therefore, you should adjust your allocation according to your own personal circumstances.

Consider your situation carefully today. Once you get into the habit of setting aside money for your retirement, it will be easy and you probably won't even miss it. You may even enjoy watching your savings grow. Remember, you can always adjust your retirement savings plan and investment decisions as your situation changes.

For more information on retirement, including IRAs, 401(k)s, pension plans, or social security benefits, read the relatedarticles in our Knowledge Center Library.

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