When it comes to saving for retirement, many Americans aren't doing their due diligence. According to a recent GOBankingRates survey, a third of Americans currently have no retirement savings. And the problem is worse among millennials, who are 40 percent more likely to have $0 in savings than members of Generation X.
Fortunately, members of the millennial generation can take steps to turn this trend around. As a worker in your 20s, you can invest in your employer’s 401k plan. The main retirement savings vehicles available to American workers, 401k plans offer great benefits, provided that employees take advantage of them early.
Here are some tips on how to start investing for workers still in their 20s.
1. Start Early
From launching their careers to purchasing their first homes, millennials have numerous responsibilities competing for their attention. However, it's important that 20-somethings make investing in their 401k accounts a priority, as well. These funds represent quick, easy and painless ways to start investing and saving for retirement. And because the money comes out of your paycheck automatically, you won’t have a chance to spend it on something else.
According to a U.S. News & World Report article by financial expert Emily Brandon, individuals who start saving at age 25 have an easier time netting $1 million by age 65 than workers who wait until they're 35 or older to start saving.
"If you wait until 35, the amount you need to save more than doubles," wrote Brandon. "Beginning at age 35, you will need to save $9,894 each year to accumulate $1 million at age 65. If you further delay saving, you'll need to tuck away $22,798 annually beginning at 45, or $67,643 at 55, if you hope to be a millionaire upon retirement at 65.”
2. Start Small
Millennials are often burdened by college loan debt and other bills that can make it hard to maximize savings.
According to Clint Haynes, financial planner and founder of NextGen Wealth, workers should start small with 401k contributions and increase the amount each year by at least 1 percent.
"When you begin contributing to your employer’s retirement plan, start off with an amount you are comfortable with and know you can afford," said Haynes.
Retirement is a journey, and starting young gives you a leg up on reaching your ultimate retirement goals.
3. Pay Attention to Fees
Different 401k plans offer varying investment menus, but most provide at least one low-cost index fund option. According to Grant Bledsoe, financial planner and Three Oaks Capital founder, it's important that investors in their 20s limit the fees they're paying.
"401k plans are notorious for charging confusing and hidden fees to participants," said Bledsoe. "And while you can’t control most of the fees for operating your plan, you can control which investments you choose. While you’re in your 20s, concentrate your account on lower-cost investments. The lower your expenses, the higher your returns.”
An SEC study showed that the impact of fees can be significant. On a $100,000 portfolio, a 1 percent increase in annual fees eroded the value by almost $30,000 during a 20-year time frame.
For best results, choose low-cost index funds that are also low on fees.
4. Increase Contributions Each Year
Contributing the maximum of $18,000 per year to a 401k is a great way to increase your overall savings. If you're struggling to come up with this investment, consider using your annual bonus or raise.
Said financial advisor Peter Huminski of Thorium Wealth Management, “Far too many people get a raise every year and don’t use part of it to increase their 401k contributions. This is a big mistake. You won’t even miss 1 percent of your raise because you didn’t have it last year. Just sock it away into your 401k and forget about it until you are getting ready to really think about retiring.”
5. Contribute as Much as Possible
While many 20-somethings will not be able to contribute the full $18,000, they should invest as much as possible.
Todd Tresidder, money coach at Financial Mentor, said, "Just max out your tax-deferred retirement contributions from your first paycheck. That’s all. You can learn all about investing and asset allocation later, but you can never recover lost time, so start now by maxing out your contributions.”
As an added benefit, contributions made early in your career have a longer time to grow and enjoy the benefits of compounding interest over the course of your working life.
6. Get the Full Match
Individuals who don't contribute enough to get the full match are effectively leaving free money on the table.
"I have run into far too many recent college graduates that are not participating in their company-sponsored retirement plan," said Huminski. "This is a big mistake. First off, they might be missing a matching contribution that the employer will put in on their behalf. This can be anywhere from 2 percent to 6 percent or more of their salary. That’s free money they are missing out on. Second, they are missing out on the power of compounding. Time has proven to be a powerful driver of investment performance.”
If your company does offer matching contributions, make sure to contribute at least enough to get the full match. Then, slowly increase your contributions as you are able.
7. Consider the Roth Option
Many 401k plans offer options to direct the payroll deferral portion of contributions to a Roth 401k account. Any matching contributions made by the company will still go to a traditional 401k.
Joseph Carbone, Jr., financial advisor with Focus Planning Group said, "While you are young and probably not in a very high tax bracket, employees will want to find out if their company offers a Roth 401k feature. The Roth 401k is funded with after-tax contributions, and once age 59 and a half is reached, distributions are tax free. I always advise my clients to check with their tax preparer and find out if the Roth 401k is appropriate for them.”
Additionally, the Roth 401k option allows for a larger contribution than a Roth IRA, which also has income limitations. Because individuals in their 20s are less likely to be in high tax brackets, Roth contributions might make more sense for them.
Not all 401k plans offer Roth options. Check with your plan’s administrator for details.
8. Use Target Date Funds Carefully
Target date funds are professionally managed accounts, usually composed of diverse mutual funds and targeted to the years in which investors will reach normal retirement age. Target date families, such as The Vanguard Group, T. Rowe Price and Fidelity, all offer their funds with target dates in five-year increments.
The funds with the longest dates will be the most aggressive in terms of their allocation to stocks, with investments becoming more conservative over time. Still, not all target funds are created equal.
While Vanguard uses an inexpensive indexing method, other fund families come with far greater expenses. As an investor, it's crucial that you understand how the target date fund distributes your wealth.
9. Take Some Risks
Investors in their 20s have many years to go before retirement. As a result, these workers can afford to take some risks with their portfolios.
In the context of 401k investing, taking risks means allocating more money to stock-based investment options within the plan or to a target date fund with a long date. These longer-dated funds will have the highest allocations to stocks and are more likely to pay off over time, despite fluctuations in the market.
10. Don’t Ignore Your 401k When Changing Jobs
While reports on millennial job hopping might be exaggerated, the odds are good that workers in their 20s will change employers at least a few times throughout their careers. As a result, it's crucial that you manage your old 401k each time you leave a company.
When you switch companies, your options will include:
- Leaving the money in your old 401k.
- Rolling the money into the 401k at your new employer, if applicable and if the new plan allows.
- Rolling the funds into an IRA.
- Taking a distribution.
Be sure to read and understand all of the rules associated with leaving money in your old 401k. Additionally, workers should note that taking a distribution early results in a 10 percent penalty, along with income tax costs.
Whatever option you choose, it's important to make affirmative investment decisions regarding your 401k money and view it as a crucial part of your overall portfolio.