The Millennial’s Guide to Saving for Retirement
For most Millennials (the generation typically defined as those born between 1981 and 1996), retirement might feel eons away. And while it might be some thirty years or more before many millennials hit that golden age of 65, like anyone, the generation should still be focused on saving for retirement today. If 2020 has taught us anything, it is that plans can unravel in a heartbeat, the economy can tank at a moment’s notice, and generally, life doesn’t usually unfold as we would expect. In fact, though many young people are simply not conditioned to expect the unexpected and plan for contingencies, doing just that is more vital now than ever. Not to mention, income to which older generations are entitled, from traditional retirement vehicles like Social Security to company-sponsored pensions, are no longer guaranteed. As such, the sooner millennials begin to sock away extra funds for retirement, the better.
In this guide, we discuss how millennials can and should be thinking about retirement today and in the years to come to set themselves up for financial success in their golden years.
1. No Matter How Little, Start Saving Today
If you are a millennial who has not already started to save for retirement, there is no better day than today to begin – no matter what amount you contribute. Whether it is $50 or $1,500 a month, it’s never too early to start to cultivate the habit of socking funds away each month. This way, when you are able to stash more away, you can seamlessly transition to contributing more toward retirement. On the other hand, if you do not begin saving now, it will be more challenging to achieve your retirement goals even when you have money to put aside.
If you can only save a small amount at first, consider a high-yield savings account as an option, which allows you to contribute whatever you can and can change your contribution amount as your income and budget shift. Another option is a micro-investing account, such as Acorns, where you can invest your spare change (those small, seemingly insignificant amounts that snowball and increase over time). These accounts allow you to save for retirement without even having to think about it.
No matter where you stash your money, however, the bottom line is this: what matters most is developing the habit. Condition yourself to invest your extra cash in your future rather than falling prey to every instance of instant gratification that comes your way.
2. You can Pay Off Your Student Loans and Save for Retirement at the Same Time
A substantial percentage of millennials leave school and enter the workforce with at least some student loan debt. While it is wise to pay off your student loans, do not forget about retirement while doing so. It is possible to pay off student loans and save for retirement at the same time. The challenge is determining how much to save and how much to pour into your loans – particularly when cash flow is already limited. Here is a rule of thumb: First, consider the interest rate on your student loans. If you have a student loan with a low interest rate (e.g., 3%), it may make the most sense to use any extra cash you have to invest in retirement instead of aggressively paying down your debt. On the other hand, if you are saddled with a high interest rate loan, it may be better to pay that off as soon as possible, especially if the interest rate is higher than what your investments would be earning.
Based on this analysis, decide how much of your income to allocate toward paying off your loans and how much to put toward retirement. But remember, even with high interest rate student loans, try to get in the habit of saving something for retirement each and every month, even just a few dollars. This will ingrain the saving habit in you so that, when you pay down your loans, all you will need to do is increase your contributions. The best part? You likely won’t even miss that money.
3. Behold the Magic of Compound Interest
What makes retirement savings so exhilarating is that you set yourself up to make more money off of what you’ve already invested. This money grows with the market, so the earlier you start to save, the more your money will grow. Why is that? You can thank the magic of compound interest. Let’s illustrate through an example.
Assuming a rate of return of 7%, if you invest $5,000 a year from age 25-35 ($50,000 total), at age 65, that amount will have grown to $602,070. If you invest $5,000 a year from age 35-65 ($150,000 total), that amount will only have grown to $540,741 by age 65.
As you can see, you win big when you give compound interest more time to work its magic. The sooner you can grasp this concept, the better, as it will surely motivate you to begin to save early and often – and to trust that even the smallest amounts make a difference in the long-term.
4. Take Advantage of Common Retirement Investment Vehicles
Now that you understand compound interest and how important it is to save early, the question becomes: where should you save your hard-earned money? Here are a couple of common retirement investment vehicles:
- 401(k): Offered by your employer, a 401(k) is one of the most common retirement tools. Your contribution is taken right out of your paycheck, and any contributions to your 401(k) are deducted from your taxable income, likely reducing your tax liability. Some employers even offer matching contributions. If yours does, do everything in your power to contribute at least up to the matching amount. If not, you are essentially passing on free money!
- Traditional IRA: This is another retirement vehicle but is not sponsored by your employer. With a Traditional IRA, you contribute pre-tax dollars to the account and watch it grow until retirement age, at which point the earnings in the account are taxed when withdrawn.
- Roth IRA: Like a Traditional IRA, a Roth IRA is another tax-preferred retirement account. With this account, you contribute after-tax contributions, which then grow during retirement and can be withdrawn tax-free when you retire.
Because of the differing tax treatment of these accounts, it is best to discuss your specific situation with a financial professional or accountant to determine which investment vehicle (or combination of vehicles) is right for you.
5. Set a Goal and Develop a Plan
It’s vital to set a goal for retirement, as this goal will guide how and when you save, as well as how you manage your retirement accounts. Figure out how much money you will actually need in retirement and work backward from there. While this is an ever-changing and complicated question (nobody can predict the future), you can start by doing the following:
- Determine at what age you want to retire and estimate how many years you will be living during retirement.
- Calculate how much income you will need a year to live comfortably during retirement (most people choose about 75% of their current income as a target, but this will largely depend on your current income and what you plan to do and where you plan to live during retirement).
- Work backward to determine how much you will need to save, at what interest rate, to reach your goal. This number can and will change, but it is good to have a goal in mind.
- Decide how much money you need to put away toward retirement a month (most financial professionals suggest 20% of your income for those over 30).
This might sound overwhelming, but a goal can help focus you and keep you on track. No matter what, so long as you remember to start saving, and save consistently, you will be well on your way to reaching your retirement goals.