Retirement Strategies For Young Adults
Most young adults aren’t sure when they should start saving up for retirement. Right now many millennials are more focused on paying off student loan debt while dealing with the economic fallout of COVID-19. It’s important to start saving up your income much earlier in life so that you are prepared for retirement later in the future.
In order to build long-term wealth, millennials will need to start prioritizing their retirement savings goals. Making simple changes can help you avoid any financial obstacles that make it difficult to save up for retirement. Here are 5 retirement strategies that can help young adults start to prepare for the future.
1. Open A 401 Account
A 401 is a retirement plan that allows employees to contribute a portion of their income to individual accounts through payroll deductions. With a 401 you can deduct contributions on your tax return which can help you save a ton of money each year.
If you start making regular investments to your 401 account in your early 20s or 30s this will allow your tax-free savings to have time to grow. Making contributions to your 401 at a young age enables you to maximize your long-term gains and minimize your losses.
Employees are able to make contributions to their account up to an acceptable dollar limit which is set by the Internal Revenue Service . With a 401 plan, any contributions that an employee makes to their account will reduce their annual income taxes but withdrawals will still be taxed.
The Most Common Questions Young Investors Face
As young adults, we face many questions as we age, not least among them is how to handle our money. Understandably, if you havent had extensive exposure to personal finance or sound financial planning while growing up, you might not have a clear answer to several burning questions you likely face right now.
Some of the most common questions young adults face regarding money include the following 4 items:
Lets explore these 4 top-of-mind questions and you can develop a clearer answer to each with sound investment advice for young adults.
Check Your Retirement Savings Progress
T. Rowe Price analysis suggests that 45-year-olds should have three times their current income set aside for retirement. This savings benchmark rises to five times their income at age 50 and seven times at age 55. Fortunately, theres still time for even modest adjustments to have a large impact down the road. If possible, aim to contribute the maximum amount to your retirement accounts. Moreover, your retirement contribution limits increase in the form of catch-up contributions once you turn age 50, allowing you to focus even more on saving what you need to reach your target.
Contribution Limits
*Additional contribution amount allowed for people age 50 or older.
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Compound Interest Is Your Friend
However, the next year youll gain 3% of $1,030, which means your investment will grow by $30.90. A little more, but not much.
Make sure you set realistic expectations and goals, and make sure to have all the necessary information when you meet with an advisor or start mapping out a plan on your own. A few things you may need to consider during your analysis:
Fast forward to the 39th year. Using this handy calculator from the U.S. Securities and Exchange Commissions website, you can see that your money has grown to around $3,167. Go ahead to the 40th year, and your investment becomes $3,262.04. Thats a one-year difference of $95.
Notice that your money is now growing more than three times as quickly as it did in year one. This is how the miracle of compounding earnings on earnings works from the first dollar saved to grow future dollars, says Charlotte A. Dougherty, CFP®, founder of Dougherty & Associates in Cincinnati, Ohio.
The savings will be even more dramatic if you invest the money in a stock market mutual fund or other growth-oriented investments.
Should I Invest Aggressively Just Because Im Young
When you have time on your side, the common advice for young investors is to invest aggressively. This usually holds true because you have little to lose and need a path for accumulating wealth with higher returns.
To accomplish this task, the typical portfolio recommendation includes investing in a high percentage of stocks and a small percentage of bonds or cash. Undoubtedly, in a vacuum, this logic proves sound but only truly represents half the story young investors face.
In fact, the missing half should serve as the most important part of your financial decision-making: your financial foundation.
Before proceeding in earnest with building a long-term investment portfolio, such as funds set aside for retirement, you will need to build other financial accounts important for financial security.
While retirement accounts and other excess money you want to invest should bias toward riskier assets , learning the best ways to invest money in your 20s should also include building these account balances to accomplish other nearer-term goals.
Before we throw everything in a retirement account and wait 40 years to withdraw, lets look at some examples of goals which should not have aggressive risk-taking, high return investments just because were young.
An Emergency Fund.
You know whats more important than holding a low-cost index fund which doubled in value over a five year period? A fully funded emergency fund capable of covering at least 3-6 months of expenses.
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Finally Learning Those Financial Terms
According to research that was conducted by Pew Research in 2011 and 2012, about 27% of adults ages 18-22 admit feeling not too or not at all confident that they will have adequate financial resources through income and available assets to last them through their retirement years.
A major step in preparing adequate retirement strategies is simply informing yourself by reading highly rated personal finance books and learn some of the key terms in financial savings. These may include IRAs, 401s, and an understanding of assets particularly as they apply to your own individual financial situation.
What is an IRA?
An Individual Retirement Account is just one of the common terms tossed around in discussions of retirement strategy. As a type of savings account available in the forms of a ROTH IRA, deductible IRAs, and nondeductible IRAS IRAs are designed to help individuals save for their retirements while also offering tax advantages along the way. These can be set up at your bank, through an investment firm, or through an insurance company. Any person that receives or earns income is eligible to start an IRA account, and you will often see doing so as one of the top recommended steps when beginning your retirement planning.
What is a 401?
Invest In A Savings Account
A savings account from your local bank may not get you a great rate, but you can deposit and withdraw as much as you wantwhen you want. Every bank has its own rules, though, which means some may require a minimum balance or restrict the number of withdrawals before they charge. But, unlike registered retirement accounts, there are no tax deduction benefits with a savings account. In other words, any interest earned on the savings is taxed in the tax year that it was earned.
The other benefit of having a savings account is convenience. You can use a savings account for whatever you need, whether for short-term expenses or longer-term needs. You may be saving to purchase appliances for your home, a trip, or a downpayment on a car or homewhich is when a savings account will come in handy.
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You Dont Have To Do This Alone
Planning for retirement doesnt have to cramp your style. A financial advisor can help you create a plan that gives you freedom to live your life today while you build wealth for tomorrow.
Not sure where to begin? Talk to an investing pro who can help you set up an investing plan thats just right for you. Its your future, so take control of it now.
About the author
Ramsey Solutions
Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.Learn More.
Home Buying And Real Estate Investment Trusts
Real estate investment trusts, or REITs, allow you to invest in large-scale real estate without actually buying property.
Many REITs are registered with the U.S. Securities and Exchange Commission and are traded on the stock market. Non-publicly traded REITs carry more risk.
REITs let you add diversified real estate to your investment portfolio and may offer higher dividend yields than other investment options.
Buying a home is another way to invest in real estate.
Purchasing a home allows you to build large amounts of equity you can borrow against. Plus, most property values increase over time.
An initial $6,000 down payment on a $250,000 home can result in owning an asset worth $300,000 or more in 30 years.
However, purchasing a home in your 20s has its drawbacks. First, its expensive and high mortgage payments may limit your ability to invest elsewhere.
Its also a major responsibility with ample upkeep and maintenance costs over time.
Finally, the permanence of homeownership makes it difficult to move quickly for a new job or marriage. Its important to analyze the potential cost benefits before purchasing a home.
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Roth Ira Tax Benefits
The Roth IRA, introduced in 1997, works differently. Suppose that you contribute the same $6,000 a year for 40 years to a Roth IRA. You dont get any tax deduction, but the Roth IRA still grows to $1.6 millionassuming the same 8% annual return. At age 63, you start to withdraw $50,000 per year.
The difference now is that there is no tax due on the Roth withdrawal, because distributions from a Roth are tax free as long as you have had a Roth account for at least five years and reached age 59½. In this scenario, you can withdraw $50,000 and keep the full amount.
Another key difference between Roth and traditional IRAs is that Roths are never subject to RMDs during the original owners lifetime. So if you dont need the money, you can simply pass it along to your heirs when you die. Theyll have to withdraw it eventually, but their withdrawals can also be tax free.
Save As Much As You Can
Along with the benefit of compounding, a higher contribution rate is especially useful if youre scared by stock market risk and prefer a less aggressive portfolio.
The Vanguard study found that a retirement saver starting at 25 saving 9 percent of salary annually with a moderate allocation finished with 13 percent more than by contributing 6 percent in an aggressively-invested account.
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How Do I Choose An Ira
Though there are several different types of IRAs, you may not be eligible for all of them. Individual taxpayers can choose from traditional and Roth IRAs, while anyone who is self-employed or a small business owner can choose from SEP and SIMPLE IRAs.
When choosing an IRA to start saving for retirement, you’ll most likely be deciding between a traditional or Roth IRA. Key factors to think about are your financial goals, timeline to retirement and risk tolerance. If you’re closer to retirement, you’ll probably want to go with investments that are lower risk and have less potential to lose money as you near your nonworking years. The advantage of choosing an IRA from a well-known brokerage firm or bank is that they help you assess what would be the best investments depending on your other goals, how soon you want to retire and how conservative you want to be.
For the more active investors, look at IRAs offered by online brokers like E*TRADE. For the more passive investors, consider an IRA from a robo-advisor, such as those from Betterment. Robo-advisors rely on algorithms to manage your portfolio for you, taking into consideration your risk tolerance and goals.
For a more personal experience, consider IRAs offered by big brokerage firms like Charles Schwab, Fidelity Investments and Vanguard that provide access to human advisors.
How To Build Your Net Worth
While your investment portfolio is a big part of the net worth equation which you can calculate by adding up the value of your assets and subtracting your debt it’s not the only thing that can potentially contribute to your financial well-being in retirement. Here are five ways to increase your net worth.
Depending on where you live and when you purchased your abode, a house can end up being your most valuable asset and a lot of people do sell their home later in life and then use that money to help fund their retirement goals. Real estate can be a great asset because it tends to rise in value over time though as we saw during the Great Recession, that’s not a guarantee by any means. While renting can be cheaper, and you can then invest the difference and potentially earn more over time than you would on a house, real estate essentially forces you to save. As you pay down your mortgage, and as the value of your property rises, your net will increase.
A business can add a lot of value to someone’s net worth or not. While many businesses do provide a decent living for their owner, they’re an illiquid asset, often hard to value that takes time to sell. Putting a price on a business is a lot harder than coming up with a sale price for a home, though, so talk to an expert who can help you set a valuation and determine how much your operation may net.
How to recover from a setback
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Invest Early No Matter How Small
Time is on your side. Because of the wonder of compound interest, as little as $200 a month invested in your twenties can build to millions by the time you retire. But realistically, how many young adults in our economy have $200 a month to put into retirement savings?
The recommended allocation for retirement savings is 15% of your income, but this is often an unrealistic number. The key is to stop worrying about percentages and focus on saving something. Even small contributions to a 401K or Roth IRA when youre young will put you much further ahead. You can always invest more heavily once youre in a better financial situation.
Retirement Tips Young Adults Can Implement Now
Recent studies have shown that a large percentage of young adults under 35 are declining enrollment in employer-provided retirement plans. Considering the economy, its understandable that many young adults are finding it impossible to focus on things any further off than paying student loan debt, purchasing a home or vehicle, and getting started in their careers.
Many wont be financially able to leave their parents home until well into their twenties. Even if theyre interested, todays young adults find it hard to sacrifice a portion of their often meager wages for retirement savings. Especially if theyre barely getting by as it is.
Considering this trend in the next generation, some companies that employ mostly younger adults arent bothering to offer retirement plan options and are choosing instead to pay higher wages. While this may be saving companies money and allowing Generation Y or Millennial adults to channel their money into immediate debt-payoff or other savings goals, its not encouraging the younger generations to think about and plan for the future.
Market research shows that those who are actively saving and investing for their retirement are in the 35-65 age bracket. But, according to many financial experts, this is alarmingly late in the game. The obvious dilemma is that young adults need to start saving for retirement as soon as possible while not floundering under other financial obligations. Its a challenge, but it can be done.
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How Much Do You Need To Save For Retirement
We do not all need 1 million dollars to be happy and isnt this the ultimate goal to be happy? At some point, your savings will be enough to support your basic expenses many options will come to you.
Lets say you live a nice middle-class lifestyle with a few frugal tricks here and there and you are able to live off $40,000 per year. The traditional amount to safely retire off your investments, according to the Trinity study, would be $1,000,000 invested in a 75% stocks and 25% bonds portfolio.
Even going back a century and testing your portfolio with the Monte Carlo simulation offered in Personal Capitalsretirement tool will give you a high rate of success with such a nest egg. However, you might not want to work that long and would prefer stopping before the million.
Best Long Term Investments For Young Adults
For young adults, time is on their side in terms of investing. They can take advantage of compound interest and tax-advantaged investments when they invest long-term.
Young investors can take advantage of aggressive investing in their 20s and 30s and hold some of the best investments for the future.
Read below for the best long-term investment for young investors, including debt elimination, property ownership, contributing to tax-advantaged accounts and then some common investments these accounts hold.
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