Top Ways to Save for Your Retirement in Your Twenties and Thirties

Part one of a two-part series.

It stands to reason that financial planning in your twenties and thirties might involve juggling multiple priorities, from paying down debt and establishing an emergency financial cushion, to mid-range goals like funding a vacation and saving for a down payment on a home. For those who have or are planning for young children, child care costs alone are another major expense. When your budget is stretched and it’s still early in your career, your first instinct might be to postpone plans for building the nest egg that will allow you to live comfortably once you’ve left your working years behind.

However, you’re also at a huge advantage when it comes to retirement planning when you’re young because you stand to benefit from potentially exponential growth that can occur when your money stays invested over several decades. The earlier you start investing on a consistent basis, the more your money can grow as earnings are reinvested and compound. Even small contributions to a tax-advantaged retirement fund can potentially yield you sizeable returns with compounded growth over a long-time horizon. 

Over the next couple of weeks, we’re highlighting strategies that can put this exponential function to work in your favor, and optimize opportunities to create a foundation for greater wealth and a more secure financial future that begins in your twenties and thirties. First up, we’re exploring how to make the most of some typical work-related benefits that can help you maximize your long-term savings:

Investigate your employer-sponsored retirement plan. 

If you don’t have a defined benefit plan like a traditional pension with a guaranteed payout in retirement, but do have access to an employer-sponsored retirement plan such as a 401(k), 403 (b), Thrift Savings Plan (TSP), or Roth versions of any of these plans, there are compelling reasons not to overlook the considerable advantages they can offer. But as with any major decision you make in regards to something as critical as retirement planning, it’s generally best to meet with a qualified financial professional who can steer you toward taking the right course of action based on your goals and personal financial situation.

Qualified retirement plans like a 401(k) allow you to contribute a percentage of your paycheck into a tax-advantaged savings and investment account. Many employers will match some portion of your contributions to one of these plans, which essentially amounts to free money for you. Typically, you select one or more of the plan’s funds based on factors like your needs, age, tax situation, and tolerance for risk. Mutual funds are the most common investment option in these plans, which might include a mix of stocks, bonds, and short-term investments like money market securities (you decide the asset allocation). The selection of funds generally will include a spectrum of choices, ranging from conservative income funds comprised of high-quality bonds and other safe assets, to more aggressive funds that carry more risk but have high growth potential. 

Don’t leave money on the table. All else being equal, it’s generally advisable to contribute enough to earn the full match from an employer-sponsored retirement plan.

If your employer offers matching contributions, most financial experts would recommend that you contribute at least enough to the employer-sponsored plan to get the maximum match amount.  For instance, if your company will match 50% on the dollar up to the first 5% of your salary that you defer to the plan and you make $72,000 per year at your job, you would need to contribute a minimum of $3,600 to get the full match from your employer.  

Be aware of the tax treatment of your employer-sponsored plan. Although both traditional and Roth variations of a 401(k) account offer tax-saving benefits, they differ in terms of how you are taxed.

While a workplace is not required to provide a Roth option if they offer a qualified retirement plan such as a traditional 401(k), many employers these days do offer this feature. The primary difference between a traditional 401(k) and a Roth 401(k) concerns how you are taxed.

Choosing between a Roth option and a traditional plan can be a somewhat complicated decision which is best made in consultation with a qualified financial professional who can provide guidance according to your overall financial situation and tax-planning needs. However, having a basic understanding of this key difference will enable you to make an informed decision. 

With a traditional 401(k), your contributions to the plan will be funded with pre-tax dollars. That is, you won’t pay taxes on contributions and earnings until you take distributions on the account. A traditional 401(k) is tax-deferred, because it enables you to reduce the amount of taxes you pay in the current year by lowering your adjusted gross income. 

If you choose a Roth 401(k), your contributions are made after taxes have been applied. Although you don’t deduct your contribution to a ROTH 401(k) in the year you contribute, your investment earnings grow tax-free, and qualified distributions are made tax-free.

A potential advantage that a Roth option offers younger people who are still early in their careers is the ability to make tax-free withdrawals in retirement, when their tax rate may be higher. However, the future is of course an unknown variable, and it’s important not to disregard other important considerations when weighing which option makes the most sense for you, such as how and when penalties for early withdrawals are applied, and required minimum distributions in retirement (a traditional 401(k) requires them). Find a helpful overview at “Roth 401(k) vs. 401(k): What’s the Difference?” from Investopedia.

You can save and invest a lot more money with a 401(k) versus an individual retirement account like a traditional IRA or ROTH IRA.

While individual retirement accounts (IRAs) and ROTH IRAs also enable you to contribute a portion of your income to a tax-advantaged investment account, a qualified retirement account available through an employer allows you to save a lot more money with higher contribution limits. 

As NerdWallet points out, a 401(k) will allow you to save more than three times as much as in an IRA. For those in their twenties or thirties, the maximum combined contributions to all IRAs (and Roth IRAs) can be $7,000 in 2024. The contribution limit for a 401(k) or Roth 401(k) for those in this age range is $23,000. 

On the other hand, don’t necessarily dismiss an IRA out of hand. You can contribute to both types of retirement accounts at the same time, and individual retirement accounts may offer certain advantages over your employer-sponsored plan.

Having a 401(k) plan doesn’t preclude you from contributing to an individual retirement account like a traditional IRA or Roth IRA. But be aware that eligibility and contribution limits will apply. While an IRA is often a primary retirement savings instrument for those who are self-employed, there are also valid reasons that those with access to an employer-sponsored plan may want to contribute to an IRA or Roth IRA in addition to or in lieu of their workplace plan. 

Why you might opt to supplement your employer’s plan with an individual retirement account, or even decide to contribute only to an IRA.

An employer-sponsored plan generally has a limited selection of investments, and some have high portfolio management fees that can diminish your returns, which can significantly reduce the size of your nest egg at retirement. 

If you want more control over your investments and your workplace retirement plan comes with high administrative fees, Nerdwallet  suggests that you consider contributing enough to the company plan to earn the full contribution match, and then funding a traditional or Roth IRA. If you can still afford to sock money away after contributing enough to earn the full contribution match in your 401(k) and after maxing out contributions to an IRA, you might think about putting these additional funds in the employer-sponsored account to take advantage of the tax benefits. 

On the other hand, if your workplace does not match any portion of your contributions, it might make sense to max out an IRA or Roth IRA before contributing to the qualified retirement plan the employer offers. But again, it’s usually best to consult with a qualified financial professional or tax advisor who can provide guidance based on your unique financial situation and tax-planning needs.

The Police Credit Union does not provide Tax, Legal or Accounting advice. Members should seek their own professional counsel in these matters.

Consider using a health saving account to help hit your retirement goals.

If you have a high deductible health plan and have access to a health savings account (HSA), you likely know that it can be an excellent way to reduce your taxable income and save for out-of-pocket medical expenses including doctor visits, dental cleanings, prescriptions, eyeglasses and more. If eligible, you can fund an HSA with pre-tax funds from your paycheck and make tax-free withdrawals for qualified medical expenses. 

What’s perhaps less widely known is that an HSA can also be used to supplement your retirement savings. In contrast to a flexible spending account (FSA), you don’t have to spend the money in an HSA within a specific timeframe — the money can be rolled over from year to year. Contributions to an HSA can be invested and grow without being subject to federal taxes (although California and New Jersey tax HSA earnings). Once you reach age 65, you can withdraw money held in an HSA for any reason without penalty. However, you will pay ordinary income taxes on withdrawals not used for qualified medical expenses.

Consider boosting your retirement fund as your pay increases or you earn additional income.

While retirement planning goals will vary according to the individual, financial experts generally recommend aiming to invest 12 to 15% of your gross income (earnings before taxes and other deductions) in a retirement fund each year once you’ve paid off any non-mortgage debt and have a comfortable level of emergency savings. Crucially, you would include any employer match in this calculation. 

However, when you’re balancing saving for retirement with other important goals like paying down high-interest credit card debt and establishing a financial safety net of cash reserves, you might want to start by investing a smaller percentage of your income, and contributing more as your pay increases. To prop up your retirement savings, you could also earmark a portion of the funds you receive from a side hustle or another income source to an IRA account. And if you receive a bonus and your retirement plan allows for it, you might consider authorizing that a portion of it be directed to your 401(k).

Fortunately, you don’t need to invest a massive lump sum to substantially grow your net worth when you have decades until you’ll need the money. To illustrate, if you invested just $310 per month over 30 years in a retirement account with an 11% return, that account could grow to $869,400. When you plan for the long term, you can start to build wealth and protect your future spending power from inflation by contributing to a tax-advantaged retirement fund as early as it is possible to do so, and by keeping your money invested over many years.
 

Interested in reading more on this topic?

READ PART TWO HERE