If you’re in your 20s, you should think of saving for retirement as a marathon rather than a sprint.
Instead of focusing on the amount of money you’ll need to retire in 40 or 50 years, focus on how modest increases in the amount you save in a 401(k) or other retirement-savings plan will compound over time.
For example, suppose you’re 25, earn $50,000 a year, contribute 5% of your pay to your 401(k) and plan to retire at age 67.
If you receive matching contributions of 50% on 6% of pay, you’ll have more than $1 million when you retire (this assumes a 3% annual salary increase and a 6% average annual return on your investments). Bump your contributions up to 6% and you’ll have $1.25 million.
At this age, time is your biggest ally, because even a small amount in contributions will grow and compound free of taxes until you take withdrawals in retirement.
If you start saving in your twenties, as much as 60% to 70% of the amount you’ll have saved at retirement will come from investment gains rather than contributions, says Ted Benna, a benefits consultant who is credited with creating the 401( k) blueprint. “If you wait until age 40 to start saving, it gets flipped the other way — more will come from your contributions than your investment gains,” he says.
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You’ll need to save even more if you get a late start and, say, a bear market depresses your investment returns as you approach retirement.
Savers who start early, on the other hand, have plenty of time to recover from — or prepare for — market downturns. Starting early also gives you the ability to be aggressive, which means investing most of your savings in stocks — typically via mutual funds or exchange-traded funds — which have historically delivered the highest rate of return.
There’s a good chance you’ll change jobs several times, particularly when you’re starting out.
Resist the temptation to cash out your retirement-savings plan after you leave your job. A survey by the Transamerica Center for Retirement Studies found that 13% of millennials have at some point in their working years cashed out their 401(k) plans when changing jobs, compared with 6% of Gen Zers and 4% of boomers.
Although the amount you’ve saved during your first few years on the job may not seem like much, the hit to your nest egg will be significant. First, the amount you take out will get a lot smaller after you pay taxes and a 10% early-withdrawal penalty on it (you have to be at least 55 and leave your job to avoid that penalty).
A better option: Roll your savings into your new employer’s 401(k) plan or, if that’s not an option, into an IRA.
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