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Retirement advice for young folks

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financial advice young people 20s 401k

We had some visitors this weekend. My brother, his wife, and her two brothers dropped by for a quick visit on their way to Vancouver, BC. It was great to see them and they had a great time playing with baby RB40. We talked about bit about my leaving the workforce and Matt asked what advice I can give a young guy in his early 20s.

I told him to save up as much as he can in his 401(k) account. The 401(k) is a great retirement saving vehicle and everyone should take advantage of it. Here are just some of the advantages of the 401(k) account.

  • Tax-deferred – You don’t have to pay tax on your 401(k) contribution. We need all the tax savings we can get. This will enable the 401(k) account to grow much faster than an equivalent taxable account.
  • Employer matching – Many employers have a matching program and this is a part of your total compensation. You are leaving money on the table if you don’t contribute enough to receive the entire employer matching.
  • Automatic deduction – Once you are signed up for the 401(k), the contribution will be automatically deducted from your paycheck. This is a great way to save because if you don’t see the money in your checking account, you won’t be tempted to spend it.
  • You can take it with you – If you leave your company or move to a foreign country, you can rollover your 401(k) into an IRA (individual retirement account.) You won’t lose this investment when you change employers.

When I started working, I didn’t want to save for retirement, but my dad convinced me to contribute to my company’s 401(k) program. Talk to anyone right out of college and retirement will be the last thing on their mind, but this is the essential time to start saving for retirement. The earlier you start saving, the more time your investment will have to grow. Time is your best friend when it comes to investing because of compound interest. Every year, your interest will be added to your investment and it will generate more interest next year.

We didn’t talk long about 401(k), but I hope Matt will be able to put aside some money for retirement. He is changing jobs and saving might be difficult for a while. Most people in their 20s are still not settled down and they have many obstacles to saving. It is fun to spend money and young people live in the moment more than older folks. Who wants to think about retirement, when you are tearing up the town on the weekends?

Saving for retirement is a great habit to build when you are young. It will teach you to spend less than you earn. This is the single most important thing to learn about personal finance. I guess I should have told Matt this instead, but he will figure it out by himself if he contributes to his 401(k) account. In a few years, his 401(k) account should grow without impacting his lifestyle too much. He’ll see that saving and investing is an effective way to build his net worth.

What would be your advice to Matt and other people in their 20s? If you are in your 20s, what is preventing you from maximizing your 401(k) contribution? The max contribution amount is $17,000 for 2012. I guess that is somewhat high if you are making less than $70,000.

Update: There was only so much you say in 15 minutes and this subject needs a lot more time than that. That’s why I’m starting a new series on advice for young folks.

  1. Say no to debt
  2. Minimize Lifestyle Inflation
  3. Growing Your Income Is Essential
  4. Start investing as early as possible
  5. Your Retirement Account Options
  6. WIP…

photo credit: flicker Suicine. I couldn’t find quite the right photo for this post. I’ll do a little more work tomorrow.

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{ 48 comments… add one }

  • W at Off-Road Finance August 27, 2012, 7:27 am

    I’d say 401Ks are all about the match and taxes. The actual investment vehicles offered by most plans are questionable at best.

    It’s also about opportunity cost. If you’ve got a side business that returns 20% on capital, you’d be crazy to put money in a 401K even for a 50% match.

    • jim August 27, 2012, 10:47 am

      I’d still pursue that 401k match. The up front 50% match beats 20% return for a few years. You could even borrow against the 401k to fund your business.

    • retirebyforty August 27, 2012, 12:03 pm

      Yeap, don’t forget about the taxes. That can be anywhere from 20-40% depending on where you live and what income bracket you are in. Couple that with the matching, it’s really hard to beat the 401(k).

  • Kurt @ Money Counselor August 27, 2012, 7:58 am

    I largely agree with you Joe:
    – From day 1, aim to live far below your means and establish a personal culture of saving
    – Avoid friends who seem to equate fun with spending loads of money
    – Try to get by without owning a car–most people’s largest expense until they buy a house
    – Anything you need, look first to buy used (online, garage sales, thrift stores); buy new as a last resort.
    – Find a couple great personal finance blogs and get educated!

    • retirebyforty August 27, 2012, 12:05 pm

      It’s easy for us older folks to say this. :)
      Most younger folks want to have fun and spend money. When I got out college, I had a crappy old Toyota and I really wanted a newer car. It was a good thing that I signed up for the 401k right away and didn’t spend all my paychecks.

  • SavvyFinancialLatina August 27, 2012, 8:29 am

    I’m not maxing out my 401K because we sort of need the money to pay for living expenses. But I am contributing 17% including employer match of my salary. It’s nice to see my 401K grow every month :) My plan is to increase my 401k contribution every year by 1-2% until I finally max it out.

    • retirebyforty August 27, 2012, 12:07 pm

      That’s a good plan. You are doing very well already. Great job!

  • Kim August 27, 2012, 8:30 am

    Yeah that photo chick looks kind of scary. I think the 401K is important, but the living below his means is the key. He should be able to look at you and see that. Although in my 20’s I really thought I’d want to work forever. Having a kid changes your perspective quite a bit.

    • retirebyforty August 27, 2012, 12:07 pm

      It was past midnight and I thought I’d better get some sleep. I can try to find a new picture the next day. :)

  • jim August 27, 2012, 10:52 am

    I would recommend signing up for the 401k on the first day of work. I’d at least contribute up to the amount of the employer match. I think its good to shoot for 15% or more between your contribution and the match.

    If you sign up on the first day then you can budget your spending with the 401k taken out of your checks from day one. Its easier to start with the 401k deduction.

    I didn’t sign up on the first day because I wasn’t sure how much money I thought I needed. I wanted to figurre out all my bills first. But of course I just ended up forgetting / procrastinating about signing up for the 401k for a while. When I finally did decide to do it, I had gotten used to spending my checks so it was harder to set aside the 401k contributions.

    • retirebyforty September 4, 2012, 2:15 pm

      That’s a great advice. I signed up within the first few months and never missed the extra $$$. If you don’t see it, you won’t spend it.

  • Jeff @ Sustainable Life Blog August 27, 2012, 1:33 pm

    Best advice – dont spend more than you earn in your 20s, you’ll regret it later. I’d also make sure they knew to try and get out of debt as quickly as possible and save for retirement like you suggested. As long as they do those things, they should be fine.

    • retirebyforty September 4, 2012, 2:16 pm

      That’s good advice, but it could also be taken as spending all your paycheck is fine as long as you don’t accumulate debt. :)
      Saving is important too.

  • Roshawn @ Watson Inc August 27, 2012, 1:46 pm

    I like your start early advise. I think a big challengeis being intimidated by the process, the number of options, and the number of pundits giving advice. Thereare plenty of others who do not have their best interests at heart either. I think customizing a plan for you is key.

    • retirebyforty August 28, 2012, 7:52 am

      It’s hard to figure everything else yourself when you’re young. Unfortunately many financial advisers are not very helpful either.

  • krantcents August 27, 2012, 5:10 pm

    Savings in every form is worthwhile. For now, capital gains taxes are pretty low (15%). Romney income is the rout e to go. Buy homes or condos and rent them out.

  • Tie the Money Knot August 27, 2012, 7:43 pm

    Good advice there, Joe. I absolutely think that people should also keep in mind that the “older” you will be incredibly thankful that the “younger” you had the discipline to save.

    We incrementally lose energy and overall health, it seems, as we age. Nobody wants to be in a position to desperately need to work when older. Good to think about that as well, for extra motivation on saving when young.

    • retirebyforty August 28, 2012, 7:55 am

      I’m incredible thankful to my younger self for not getting into debt and saving for retirement.
      You are right about losing energy and health. Everyone think they will work forever when they are young, but the work place may not have the same idea.

  • Pulak August 27, 2012, 10:51 pm

    its always good to start early and appreciate the sacrifices one needs to make in the present to attain a set of goals in the future.
    I am from India, and when i started off with my career i was worse than being financial illiterate….i just didn’t care about money. Not that i used to overspend beyond my means (we are from a financially conservative family and the discipline to save has always been there). But i used to see money as some sort of a taboo, which corrupts if you have too much of it.

    With age I realized i had to change my outlook towards money and not to see it as a goal in itself but as a means to attain financial freedom, to do things which i would love doing.

    I am 29 now, and i have taken baby steps in that direction. Unlike the US, personal finance education is very limited, and if given a chance people from the middle class would just dump the pain of managing one’s money to an adviser than be personally involved themselves. There are fewer options in India as well to invest.

    However, the critical thing is the discipline to stick to a ‘financial freedom’ plan and execute it consistently. That is where i am struggling these days. I started off with a broad plan last year, and that enthusiasm lasted for a while till i got busy with my office work and then the whole thing went on auto pilot.

    Its just like having the discipline to run a marathon and practice for it daily. If you lose the momentum or habit, takes some will power to restart again.

    Pulak

    • retirebyforty August 28, 2012, 7:58 am

      Hi Pulak,
      Thanks for your comment. It’s very enlightening to hear about other cultures.
      US residents have more educational resources, but we also have much more way to spend money and get into debt. Unfortunately, most people do not learn about personal finance until they are already in debt.
      Is it possible to automate your saving? That way you don’t have to think about it much. That’s what I like most about our 401k plan.
      Good luck!

  • Manette @ Barbara Friedberg Personal Finance August 28, 2012, 12:39 am

    I totally agree with you, “The earlier you start saving, the more time your investment will have to grow.” Young professionals should realize that saving up for their retirement should be their priority as soon as they get a job.

  • 65aspiringyogini August 28, 2012, 5:18 am

    My favorite economic advice to young people comes from Scott Nearing. He was asked to stand up and give a speech to a group somewhere and this was all he said: “Pay as you go.” I like this version of his biography:

    http://pabook.libraries.psu.edu/palitmap/bios/Nearing__Scott.html

    I have taken this advice to heart, myself, and have had no personal debt (no mortgage, no loans, no credit card debt) since I became financially independent 11 years ago.

    • retirebyforty August 28, 2012, 8:04 am

      Pay as you go is great advice for young people. It’s very important to avoid debt. We have several mortgages, but thankfully no consumer debt.

  • Amanda L Grossman August 28, 2012, 9:18 am

    In my first job right out of college I opened up an IRA (first traditional, then converted two years later when I learned better:)), and maxed it out. My first company did not offer a 401(K). My second company did, and I starting making enough to reach the matching contribution. Then I was laid off…..

    My current agency does not offer a matching contribution, but does have a pension. So currently my strategy is pension (mandatory anyway!) and maxing out our two Roth IRAs each year.

    • retirebyforty August 29, 2012, 4:45 pm

      Sorry to hear about your misadventures, but I guess we have to learn somehow. I’ll make sure to teach my kid about these retirement accounts when he starts his first job. Pension is great, but that’s getting more and more rare. Great job!

  • Wayne @ Young Family Finance August 28, 2012, 6:43 pm

    I can’t maximize my 401K contribution because I don’t make enough to put food on the table and pay off my massive college loans to leave a large sum like that. However, I do contribute enough to get my employer’s match!

    • retirebyforty August 29, 2012, 4:46 pm

      That’s a good start. Keep working on your student loans and they will be gone one day.

  • jefferson @seedebtrun August 28, 2012, 8:44 pm

    i have always taken advantage of my company match on the 401k, because even when working to pay off our consumer debt– it seems foolish to turn down the free money of a company match. i look forward to being able to use the 401k even further in the future. i have already seen the benefits of compound interest, already.

    • retirebyforty August 29, 2012, 4:47 pm

      The match is really too good to pass up. There is no other investment that will give you 100% return instantly. Great job!

  • First gen American August 29, 2012, 2:51 am

    I think my advice is almost the same but it would be to start saving from the very first paycheck. I remember my first real job earned over 4x what I was bringing in working odd jobs, so even though I was skimming 15% off the top for 401k, I didn’t miss it because my take home pay was tons more than I was used to earning . If you get used to that extra 15%, then try to go without it, I think it’s a much more painful adjustment.

    • retirebyforty August 29, 2012, 4:50 pm

      I also started saving from the very first paycheck. The income was still huge comparing to my tiny on campus job’s paycheck. Even with 401k contribution, I had plenty to live on. I agree 100% about the lifestyle inflation.

  • Lance @ Money Life and More August 29, 2012, 6:36 pm

    I didn’t start with a 401(k) because there was no company match. Instead I started with my Roth IRA right away. I have never missed an investment and it has taught me to be very consistent with my investments.

    • retirebyforty August 30, 2012, 8:01 am

      That’s a great start, but the limit is quite low at $5,000. You should consider adding a bit more to 401k as well. Good luck!

  • Emily @ evolvingPF September 1, 2012, 3:05 pm

    I’d say to not forget about the Roth IRA. My employer doesn’t offer a 401(k) and many of my colleagues think they can’t invest because we don’t have that benefit. Even with the 401(k) option, an IRA is a better choice (after you get all the match your employer offers) because you have more control and can seek out lower expense ratios. Then go back to the 401(k) if you have more money to invest.

    Or if that’s too complicated, just plow as much as possible into the 401(k)!

    • retirebyforty September 2, 2012, 8:19 am

      The Roth IRA is a great retirement vehicle as well. I still like the 401k better because of the instant tax benefit, but the better choice is to max out both 401k and Roth IRA. Thanks. :)

  • Sarah September 2, 2012, 11:59 am

    The best advice I ever got was to go for the job with a pension. Upon graduating, I knew I wanted to teach middle r high school, and I had my sights set on a nice, small private school. It seemed like a great cushy job, and a good way to learn the ropes of the teaching profession. A professor suggested, however, that if I was up for it (and he thought I was — I wasn’t so sure!) I should get a public school position instead. Sure, it would be more challenging, but the benefits couldn’t be matched. Now, as they say, the rest is history! My husband and I are both happily employed as public school teachers. We enjoy our jobs, but we also feel very secure knowing we have a pension and lifetime medical benefits.

    • retirebyforty September 3, 2012, 6:00 pm

      Pensions are great if you can get one. There are more and more reforms though and pension will have a harder time with longer life expectancy in the future. My in law parents have pensions and they are doing very well in retirement.

  • Bartswt September 3, 2012, 9:31 pm

    I think people get too caught up in saving so much money in a 401k or Roth IRA. Dont get me wrong, saving is good! However, with interest rates as low as they are today, how much interest are you assuming when you need to make withdrawals? Let’s assume you have $1 million in a retirement account. Then ask yourself, how much do you need to live off of? Ever heard of the 4% rule? It states that 98% of people won’t run out of $ in their lifetime if they withdraw only 4%. Of course, this assumes all of $ not being in one stock and age an throw a monkeywrench in the assumption too. Well, $1 million @4%= $40k/year… And in a 401k or IRA this is taxed as ORDINARY INCOME so your take home is much less than this number. Point I’m trying to make is this: Don’t put All your eggs in one basket and learn to set yourself up through passive income streams. Rent houses, storage units, etc. So many people right now are finding out the hard way that $1 million or $2 million is not exactly what they thought it was going to be. Taxes, taxes and more taxes are eating away their cash flow… Which is what I was getting at. It’s all about the cash flow! It’s not all about what’s coming in… It’s also about what’s going out too! It sure helps to have that mortgage paid off. It sure helps to NOT have a car payment or a modest one. Life happens and circumstances go beyond what we plan (kids and/or grand kids at home) but still, at the end of the day, your cash flow situation is what counts… It sure helps to have some passive income with rental property no matter what interest rates Re.

    • retirebyforty September 4, 2012, 7:53 am

      I agree that passive income is the way to go. It’s best to diversify your income before retirement so you have different sources such as rental income, dividend income, and more. That way you can withdraw just a portion of your 401k and minimize the tax.

  • sheena September 4, 2012, 3:08 am

    Is a Roth 401(k) a good investment for a 28-yr old? I used to contribute to both a traditional and a Roth 401(k) offered by my employer, but stopped the latter. Was that a good move?

    • retirebyforty September 4, 2012, 8:06 am

      I think it depends on your tax rate. If you are in a high tax bracket, then it’s probably better to take the tax break now and go with the traditional 401k.
      Also keep in mind that you are saving more overall if you contribute to the Roth 401(k) since you already paid the tax. I think it’s a good move to spread the contribution to both traditional and Roth 401k. It will give you more options when you need to withdraw. Good luck!

  • Mike September 4, 2012, 8:00 am

    Since I started working at my first “real” job I have been putting enough into my 401k to get the 4% match my employer provides and then putting away 25% of each paycheck into a savings account. I know that my savings is a terrible investment and makes me no money however at 25 I know that in the next few years Ill want to be able to take a large portion and put it into a down payment on a house. I have spoken to several advisors to get their opinion but they always seem to be selling me. They did mention a blanket brokrage account that I can place as a “insurance” reform and it will make the same as a typical brokage account but the gains on it are tax free. Can you speak on behalf of using a tool for the midterm such as this? 401k is great for the long term but for the midterm its not the best tool.

    • retirebyforty September 4, 2012, 2:22 pm

      If you are saving for a down payment, then a saving account is the way to go.
      If you are planning to buy a house in 2-3 years, you probably wouldn’t want to risk another stock market downturn. I’m not sure what the blanket brokerage account is. I’ll have to read up more on it.
      Most financial advisers are out to make commission on their financial products. It’s hard to find a good financial adviser. You can try US I Saving Bonds if you want a bit more interest, but it’s not much more.
      If you can buy a house, now might be the time to do it. The interest rate is low and the price is still near the bottom. This is probably better than adding to the saving account.
      Good luck!

  • Mitchell September 4, 2012, 9:42 am

    I like a lot of what I’ve seen here….I’m 22, graduated May ’11, and just got a ‘rea job’ myself. Getting company match, and putting a couple grand into the Roth IRA.

    However, I feel that the advice of ‘avoid debt’ is a little vague. I’m a big proponent of thinking of buckets of money in terms of liquidity. 401(k)/403(b)/IRAs etc are not liquid. 10 yr CDs are not liquid. Houses/alternate income streams are not terribly liquid.

    My point is that emergency funds should not ignored either. They are the key to avoiding debt. It looks like this – match max. 401(k) (7% for me), $2k / yr into Roth IRA, $3k / yr into emergency fund (money that I don’t touch at ALL), and another $2k / yr that do a 3 month rollover CD, just in case my emergency fund isn’t enough. Oh, and don’t forget paying double minimum payments on student loans, of which I have like $20k ish.

    Of course, I own a ’02 Saturn that is a basically a junker, and lived with my parents for a year….

    • retirebyforty September 4, 2012, 2:23 pm

      You are right. I’m working on a bigger series. There is only so much we could talk about in 10 minutes. :)

  • Erik September 4, 2012, 10:25 am

    If I have $10,000 to invest each year, should I contribute 100% of that into a 401K? Or 50/50 Roth IRA and 401k?

    • retirebyforty September 4, 2012, 2:25 pm

      If your 401k has an employer match, get all of that first. If $5,000 will cover it, then I would recommend 50/50 Roth IRA and 401k.
      That’s $5,000 in 401k and $5,000 in Roth IRA, right? :)
      It’s actually more than $10,000 because you already paid tax on the $5,000 going to the Roth IRA. If you can do it, that’s the way to go.

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