As Stuart Ritter instructed new T. Rowe Price hires on the retirement savings options available to them, a woman in the back of the room at a recent orientation started pounding on the table in front of her. The 53 year-old told her mostly 20-something colleagues that after she graduated from college she figured saving for retirement would be easier once she paid off her student debt. Then she fell in love, so she saved for a wedding. Then for a house, some kids and college for those kids. Easier never came and 30-years after college graduation she doesn't have any money saved for retirement. Her message: Don't let this happen to you.
“There will always be competing demands for you money," says Ritter, vice president of T. Rowe Price Investment Services. "There will always be more things you want to buy than money to buy them with. So the sooner you get past ‘O, but, I don’t have much money’ the better off you’ll be.”
You’re smart. You probably know that you should be saving for retirement. There is even a decent chance you've started -- according to a new study from Fidelity 47% of 25 to 34 year-old Americans have. Odds are higher though, that you haven't or that you have a nagging feeling that you're not doing it quite right.
Don't be intimidated. “It’s not rocket science,” Carrie Schwab-Pomerantz, president of the Charles Schwab Foundation says. Truth is, with a light shove and a bit of guidance, you can figure out this retirement thing. Below we've explained why it is important to start now (you've likely heard it before but it bears repeating) and the how-to of savings. Finally, since life changes fast in your 20s, we touch on a few 'what ifs.'
Why? Manisha Thakor, CEO of MoneyZen Wealth Management, calls people currently in their 20s and 30s retirement "pioneers." Thanks to the demise of corporate pensions and the rise of independent retirement accounts we are personally responsible for our nest eggs to a degree that would have been unimaginable just a few generations ago. The good news is that unlike baby boomers, who might have counted on a pension plan that has since been frozen, people in their 20s know from the start it's up to them.
"The sooner you start saving and investing the easier it is on your budget," notes Schwab-Pomerantz. "The sooner you start the less you have to save because you have time on your side." Money stashed away and invested when you're 22, 25 or 27 will enjoy four decades or more of market gains and compounding interest. Those powerful forces could mean $1 invested at 25 is five-times more valuable than $1 invested at 45.
How?
1. Commit to saving 10% -- Experts agree that a person starting to save for retirement in her 20s needs to put away at least 10% of her income annually, plus anything her employer kicks in as a match. Thakor explains her tough love attitude boils down to cold, hard digits. “I could tell you, ‘start with 2% or 3%,’ but the math just doesn't work," she says. “If you are putting 2% or 3% in, another way to think about it is betting you’ll croak ten years into retirement."
If 10% sounds like a lot consider this: that number will only go up if you wait. Schwab-Pomerantz is a proponent of "the minus 10 rule." This says that a person starting to save in her 20s needs to save 10%, while a person starting in her 30s needs to save 20%. If you truly can't save 10% off the bat make a plan to get there by setting up automatic annual 1% or 2% increases through your account provider. Set it to update on your work anniversary or birthday as a gift to your future self. Or, raise the percentage you save whenever you get a raise -- that way, your higher savings won't reduce your take-home dollars.
2. Get your employer's match -- According to a new report from the Investment Company Institute, just 43% of 21 to 29 year-old private sector workers had access to employer sponsored retirement plans in 2013 (typically 401(k)s). But according to Vanguard 49% of the employers using its plans provided some percentage matching contributions last year. If you work for a company that falls in the later group, lucky you, invest at least enough to get the match. (If you are not sure ask the human resources department.) While 401(k) matches are typically described as free money, most employers will only hold up their end of the bargain if you hold up yours. That means if your employer offers a 3% match, you might have to put 3% of your income into a 401(k) or more (some don't match at a 100% rate).
3. Fund a Roth 401(k) or Roth IRA -- Traditional 401(k)s and IRAs offer tax deferred savings, meaning that you don't have to pay any income tax on contributions made now, but you will pay tax on all withdrawals in retirement. A Roth account, on the other hand, is funded with after tax dollars, but allows you to pull out income tax free in retirement. Many pros suggest the Roth route for 20-somethings because your income will likely grow between now and retirement, putting you in a higher tax bracket. If your employer offers it, the Roth 401(k) is the most convenient option, but there are some downsides to sticking all your retirement money in a 401(k). A 401(k) plan typically has fewer investment options than a Roth IRA you open your self. Consider funding a Roth IRA in addition to a 401(k). Another reason to fund a Roth IRA too: in an emergency you can withdraw your original IRA contributions (although not earnings) without owing any tax.
4. Pick your investments -- If you are saving in a 401(k) (standard or Roth) your easiest option is likely a target date fund. These are essentially set it and forget it funds, which are designed to grow with you, changing asset allocation as you age. (They start with mostly stocks, increasing your bond allocation as you get closer to retirement.) “Stocks are where you make money, bonds what you hold so you don’t [panic and] sell your stocks,'' quips Thakor. A target date can be an okay choice, provided the fees charged by the target date family in your plan are reasonable. While target date funds from the Vanguard Group and the Fidelity Freedom Index series cost less than 0.20% of your assets a year, the average target date fee is 0.84% and some charge in excess of 1.25%, according to Morningstar. If your target date is pricey, look to see if you are offered low cost stock index funds or ETFs as an alternative.
If you're opening an IRA, Thakor recommends looking at Vanguard's cheap target date funds. But even Vanguard requires a minimum of $1,000 to open a Roth IRA and additional deposits must be of at least $100. A number of tech-driven financial start-ups, on the other hand, offer Roths with no minimum to open and low to non-existent other fees. One example is Betterment which automates savings and asset allocation for between 0.15% and 0.35% of assets depending upon the size of your account. Motif Investing has a family of commission-free, prepackaged ETF-like portfolios (Motifs) with the allocation of each designed for a specific time period and risk tolerance. (For more on low cost options see Maggie McGrath's "The Best Places To Save For Retirement If You Make Less Than Six Figures.") Remember this: just as saving early gives your earnings more time to compound, it also means the expenses that eat away at those earnings will compound for a long time too.
5. Max out your accounts -- Assuming you're under 50, the maximum you can contribute to a 401(k) in 2014 is $17,500, and the maximum you can put in a Roth IRA is $5,500---for a total of $23,000. If you can save that much, a good strategy is to first contribute enough to your 401(k) to snag the maximum match, then fund a Roth IRA, and then top up your 401(k) contributions. Technically you can only contribute to a Roth IRA if you make less than $129,000 as a single but there are ways around that (for more see Ashlea Ebeling's, "The Serial Backdoor Roth, A Tax-Free Retirement Kitty.") If you can save more than $23,000, open a taxable investment account and consider a strategy that lets you cram extra dollars into a Roth IRA, using aftertax contributions to your 401(k).
What if ...
I switch jobs? You have three options of what to do with your 401(k) when you move to a new company. You can keep the account with your old employer (assuming they let you), you can roll your funds to your new employer (assuming it has a 401(k) plan and takes rollovers) or you can roll your funds into an IRA. This last option is preferable. There is a good chance you will change companies several times over the course of your career, so having one centralized account prevents confusion later. Going with a high quality provider can also help you minimize fees and maximizes your investment options. Just don't cash out the money and spend it; not only will you jeopardize your retirement, you'll also end up paying a tax penalty for an early withdrawal.
I get married/have kids? New people and responsibilities do not lessen the need to make retirement a financial priority. So don't get distracted. Married couples should follow the same guidelines as singles but using their combined incomes. As Ritter says, "Your future self is counting on what today’s self is doing and is really hoping you make good decisions."
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