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Saving for retirement in your 20s can be challenging both mentally and financially. It’s hard to envision a time 35, 40, or 45 years in the future when you might not need, want, or be able to work anymore. And it can be hard to save money when you’re just starting your career since an entry-level salary plus student loan debt mean your cash flow is limited. What’s more, the perennial headlines about the massive sums young workers will need to amass to retire might seem so daunting that you don’t see the point in trying.
Besides, there are other things you could do now with any extra money you might have: go out with friends, travel, save for a house.
So why bother saving for retirement in your 20s?
Why not wait to set those financial goals until your 30s or 40s when you’ll probably be more financially comfortable and when retirement is no longer such an abstract concept?
The math shows you’ll be missing out.
Savings, compound interest, and retirement
Compound investment returns are on your side when you start saving for retirement early. Consider three scenarios calculated using one of the more popular online calculators :
Saver 1: Age 22
Goal retirement age: 65
Years to accumulate retirement savings: 43
Monthly savings: $500
Average annual investment return: 8 percent
Total savings by age 65: $2,255,844 before taxes and inflation
Saver 2: Age 32
Goal retirement age: 65
Years to accumulate retirement savings: 33
Monthly savings: $500
Average annual investment return: 8 percent
Total savings by age 65: $972,542 before taxes and inflation
Saver 3: Age 42
Goal retirement age: 65
Years to accumulate retirement savings: 23
Monthly savings: $500
Average annual investment return: 8 percent
Total savings by age 65: $395,866 before taxes and inflation
When you start saving $500 a month at age 22, you’re contributing an extra $120,000 in principal compared with starting at age 42. But there’s a huge difference between that extra $120,000 in contributions and the extra $1.86 million you end up with as a result of investing that principal for an extra 20 years and giving it an extra 20 years to compound. The earlier you start, the easier it is to end up with the nest egg you need. A seemingly unattainable sum becomes a realistic financial goal.
Saving less: Is it still worthwhile?
Maybe you can’t save $500 a month when you’re just starting out. Ideally, that’s what you’d save on a $40,000 salary, following the conventional wisdom that you should save 15 percent of your gross income for retirement. But that might only be attainable if you’ve landed a job in a high-paying field or if you’re living with your parents to help make ends meet while you get started in your adult life. Let’s assume you can only save $100 a month for retirement. How does the math look then?
Saver 1: Age 22
- Goal retirement age: 65
- Years to accumulate retirement savings: 43
- Monthly savings: $100
- Average annual investment return: 8 percent
- Total savings by age 65: $451,169 before taxes and inflation
In this scenario, you come out more than $50,000 ahead by saving $100 a month starting at age 22 versus saving $500 a month starting at age 42 in our original comparison.
How much would you need to save per month if you waited until age 32 or 42 to start saving and you wanted to end up with the same $2,255,844 you would amass by starting to save $500 a month at age 22, assuming the same 8 percent rate of return?
- Starting at age 32, $1,150 a month will get you close: $2,236,846 after 33 years, before taxes and inflation.
- Starting at age 42, $2,800 a month will get you $2,216,848 after 23 years, before taxes and inflation.
It’s easy to think that it will be easier to save larger sums in the future because your income will probably be higher, but your cash flow will likely have new demands on it: paying a mortgage, raising children, saving for your kids to go to college.
Simplifying the retirement challenge
There are a few ways to make saving for retirement easier and get closer to that $500-a-month goal:
- Get your 401(k) match. Not everyone has access to a 401(k) and not all employers who offer 401(k)s offer matching contributions. But if you can contribute to a 401(k), kick in enough to get your employer’s match. That’s less savings that has to come out of your paycheck.
- Refinance your student loans. Maybe you already have the lowest possible interest rate on your student loans, but if you don’t, refinancing could improve your monthly cash flow and make it easier to save for retirement. (Learn more: The pros and cons of refinancing student loans )
- Choose the right brokerage. Some brokerage firms have rock-bottom account opening and investment requirements. Some will even waive fees or offer discounts for setting up automatic contributions from your paycheck. In addition, there are firms and companies that offer financial advice and services in addition to their brokerage operations, which could be beneficial as your career advances and money matters get more complex. Do some research and find out what offerings might meet your needs, both now and in the future. (Learn more: MML Investors Services)
No matter how much or how little you can afford to save for retirement in your 20s, it’s important to get started. Overcoming the hurdles of opening your first retirement account, learning how to transfer money into it or setting up automatic monthly contributions, and figuring out how to invest those contributions will put you on the right track to starting a good habit that will serve you well if you follow it consistently over your working years.
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This article was originally published in September 2016. It has been updated.
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