2 Top Reasons Why You Need to Plan for Retirement in Your 20s

Planning for retirement

When you are in your 20s retirement feels like its lightyears away (at least to me it does).

Truth is, its as far or near as you make it.

Also, the quality of your retirement is 100% in your control.

Luckily you are here reading this so you will be completely prepared to start investing for retirement and will have the best retirement ever.

The day will come when you say screw it I’m DONE with working, and then you will take a look at your retirement account, get up from your desk and walk out the office never to return.

To make that day reality lets look at three keys to starting your retirement planning journey off on the right foot (and early).

  • Why you need to start planning for retirement in your 20s
  • Beginning to save for retirement in your 20s vs 30s
  • Simple ways to start saving for retirement in your 20

Let’s get into it.

Why you need to start planning for retirement in your 20s

The 2 most important reasons why you need to plan for retirement in your 20s are time and compound interest.

In your 20s time is your best friend.

It’s literally the key to a great retirement it unlocks the power that compound interest holds.

Many individuals who are in their 20s can find themselves juggling financial burdens such as student loan debt, entry-level paying jobs, and the start of marriages and families.

This can make the idea of planning for retirement feel even more daunting, but it does not have to be.

Understanding how your decisions today can significantly impact the financial health of your future self can help you to feel more confident about where and how to start.

Finding a way to plan for your retirement as early as possible will significantly help to alleviate financial stress later in life.

Having time on your side is much more than just the number of years that you have to save up for retirement.

It represents the increased number of years that you can relish in the magic of compounding interest.

It sure helped Warren Buffett out:

“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” – Warren Buffett

Ok, this is not real magic, but once you see the numbers, it will be shocking.

Compounding interest is the interest that is earned on the sum of the original principal, plus any accrued interest. Simply put, your interest begins to earn interest which begins to earn interest and so on.

To better demonstrate this concept let’s meet John.

John is a 20-year-old male who recently began working his first full-time job.

He has been saving his money and has decided to begin planning for his retirement by depositing $1,000 into an investment account. He will also be making an additional contribution of $100 each month for the next 40 years.

This equates to a total balance of $49,000 at the end of year 40.

But what if John’s money was in an account that earned him an interest rate of 10% with interest being compounded annually? (The average return for the S&P 500 over the past 90 years is 9.8%)

Now, at the end of year 40, John’s $49,000 has grown into an exceptional $604,717.

This is the magic of compounding interest!

Even if John’s $49,000 was only able to receive a 2% interest rate, his ending balance would be $75,437, which still represents a considerable 65% growth.

The earlier you begin planning for retirement, the more time you have on your side, and the longer your interest will continue to earn interest.

So, what if you are already past your 20s?

Your goal is to begin planning for your retirement right now. The sooner you start the better, but the key is to start. You cannot go back in time, but you can look forward into the future.

Beginning to save for retirement in your 20s vs 30s 

Starting to save for retirement while you are in your 20s can result in the accumulation of a significantly higher net worth versus if you were to wait until later in life to begin saving.

You might be thinking “a few years doesn’t really make that much of a difference, ill start next year”

Think again!

Delaying the start of saving for retirement can be far more significant than you might realize. A single year can result in you having tens or hundreds of thousands of dollars less than what you could have had.

When looking at the effects on your retirement when starting to save in your 20s versus 30s, it’s important to know the timeframe within which you are working.

The average 20-year-old male has a 50% chance of living to the age of 84 and a 10% chance of living to the age of 97.

As a 20-year-old female, these numbers increase to having a 50% chance of living to age 87 and a 10% chance of living to the age of 99.

With the average age of retirement being 65, this means that your retirement savings could be the main source of your income for 10-30 years. Realizing this can make the future seem not so far away.

So, what is the cost of delaying the start of your retirement savings?

Let’s meet Jane.

Jane is a 20-year-old female who has decided she wants to retire at age 60 and has begun saving $200 each month in an account that earns an average return of 6%.

With her total annual contribution of only $2,400, Jane will have a total of $383,392 by the age of 60. Why is her ending balance so high considering she only personally contributed a total of $96,000?

Compounding interest!

Now, let’s say that Jane has decided to postpone the $200 per month savings for one year.

This decision decreases her ending balance not by the annual amount of $2,400, but by a staggering $24,039.

Again that’s for holding off for ONE year What if she decides to postpone saving by 10 years and starts at 30?

The cost of delay skyrockets to $187,541, leaving her with an ending balance of $195,851 at age 60.

By delaying just 10 years Jane has lost HALF of her savings for retirement. This will drastically impact the quality of retirement Jane will have, if she is even able to retire.

I’m going to repeat that because its probably going to be the most important fact that you will hear today.

By delaying just 10 years Jane has lost HALF of her savings for retirement.

The cost of delay increases with age because you lose time; the KEY to compound interest.

Effect of Inflation on your money

In addition to compounding interest, a key factor of understanding the importance of saving for retirement is understanding inflation and the time value of money.

The average inflation rate over the last 20 years has equated to 2.08%.

Retirement planning in your 20s

This means that, on average, the prices of goods and services has sustained an increase of over 2%.

This rate could increase drastically, decrease over time, or remain steady, but it is important to know the impact it has on the value of your money.

$100,000 today will only be worth $65,297 in 20 years if inflation stays at 2%.

This represents a loss of 33%. Having time on your side not only helps you to grow your retirement savings, but it also works to battle the impact that inflation can have on that savings.

Simple ways to start saving for retirement in your 20s

Starting to save for retirement in your 20s does not have to be an intimidating task.

With a few tips, you could be well on your way to a retirement full of worldwide travel, rounds of golf, or whatever it may be that suits your retired self’s fancy.

Just remember, each person is different and so is their financial situation. Your ability to save consists of a multitude of factors, and it is important to identify what it is that dictates and influences your finances.

Tip #1: Track your spending.

For 30 days, write down everything you spend your money on. Whether it is that much-needed oil change or a pack of gum at the gas station, write it down.

At the end of the month, look through all of your expenses and categorize them into groups like bills, auto expenses, loan payments, entertainment, etc.

Look at how much you spend in each category and see if you can find areas of opportunity.

Is the number in your entertainment category a bit high? Maybe make the choice to cut back on the number of movies that you see in the theatre each month, and instead, subscribe to a less expensive streaming service.

Tracking your spending will help you to determine how much you are truly able to save each month and where this savings will come from.

I recommend you check out some budgeting/personal finance apps such as:

  • Digit
  • Personal Capital
  • Mint
  • You need a budget (YNAB)

Tip #2: Open a retirement account. 

Now that you know how much you are able to save each month, you can begin putting that money to work.

Savings for your retirement can be done in a variety of ways, and it is important to understand your options.

First, you have an Individual Retirement Plan (IRA).

A great thing about an IRA is that your money grows tax-deferred.

This means that while your money is growing and earning a return, you will not have to worry about paying the taxes on those earnings.

This allows you to maximize the current potential of your retirement savings plan.

You also have different IRA options to choose from, with the most common being a Traditional IRA or a Roth IRA.

A Traditional IRA means that your contributions are made before taxes have been taken from them, thus increasing the amount of the actual contribution.

Taxes are then paid later in life when you begin to withdraw from the Traditional IRA.

Another common option, especially among younger investors, is the Roth IRA.

The key difference is when you make contributions to your Roth IRA, taxes have already been deducted from your contributions. Therefore when it is time to make withdrawals during retirement, you will not have to pay taxes.

Both of these options are great ways to build up your retirement savings. Determining which option is best for you an important part of retirement planning.

Tip #3: Set up automatic contributions.

Most banks give customers the opportunity to set up automatic transfers to savings and retirement accounts.

These programs allow you to choose the amount, the date, and the frequency that your contributions will be made.

An automatic savings plan is a great way to stay disciplined and on-track with your plan while making it easy and consistent.

Tip #4: Review your plan.

Someone’s financial situation can change very quickly. New jobs or promotions can increase your net income or unforeseen expenses can reduce it.

It is important to remain consistent with your savings, but it is also important to adjust it as needed.

If possible, try to increase your savings plan by 2-5% each year.

One of the key reasons for this percentage is the element of inflation that was described earlier.

Giving the value of your savings a fighting chance against rising prices will put you in a better financial situation down the road.


Source: https://youareinvesting.com/planning-for-retirement-in-your-20s/?fbclid=IwAR0LnY4aHFc3UF-Jrkny_HjDuWkoUDiHBulFpH4r2tj9OzTwHRtfxGlRv-g
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