It’s been a year since my youngest daughter started her first full-time job, and she still hasn’t signed up for her workplace retirement account.
It’s not that she doesn’t want to save. It’s just that her entry-level salary as a kindergarten teacher isn’t very high compared with her peers in technology and other STEM fields. She also complains that 7 percent of her pay already is being deducted for the pension system for public workers.
Although our daughter lives at home because of the high cost of rent in our area, seeing so much of her pay going into an account she won’t — or shouldn’t— touch for decades is a hard sell.
For young adults with major financial obligations — student debt, rent, an auto loan — investing for retirement may not seem like a realistic add-on.
But as my husband and I have repeatedly pointed out to our daughter, her pension may not be enough since it’s determined by a formula based on her years of experience and final salary. And who knows what the rules will be for Social Security by the time she can collect benefits?
So, we keep pressing her to start saving for retirement in her 20s. Here are five reasons she should start now.
1. Retirement savings may not be as big a hit to your wallet as you think.
Melody Evans, a wealth management adviser at TIAA, crunched some numbers.
Let’s say you’re in your 20s and earning $40,000 a year. You decide to save 4.5 percent a year for retirement, or $1,800. Your employer matches your contribution for another $1,800.
In total, you’re investing $3,600.
Without the retirement tax advantage and at a 10 percent tax rate for the first $11,000, and 12 percent tax rate for the rest, the Internal Revenue Service would take $4,580 a year. That would leave you with take-home pay of $35,420, or $681.15 a week. (To keep things simple, Evans didn’t factor in credits, deductions or state tax.)
However, since the $1,800 is tax-deferred, the IRS would tax $38,200 — not $40,000. That means the IRS gets $4,364 and leaves you with $33,836 — a weekly salary of $650.69. In other words, under Evans’s example, your paycheck would be reduced by about $30 each week because you’ve started saving for retirement.
Historically, time is on investors’ side: Let’s say that in 2002, a 25-year-old started investing that $3,600 a year in the S&P 500 and stayed at just that amount for the next two decades. At the end of 2022, the investment would be worth close to $180,000. “We can’t predict what will happen in the future. But in this 20-year window, the annualized rate of return was 8 percent,” Evans said.
2. The power of compounding is a tremendous force.
Don’t squander your biggest financial asset: time.
Start saving in your 20s and you’ll have time for your money to grow. You’ll have time to enjoy the fruits of compound interest. You’ll have time to weather stock market volatility.
“It’s common for young people to wait for a point when they will start saving, and that’s going to be when they’re more established in their careers and they have extra to save,” Evans said. “But just like you automatically deduct money to pay for your utilities and your cable bill, consider automatically deducting money from your paychecks and use it to build your retirement savings.”
If you wait to save whatever is left over, you might never get started, she warns.
3. Get the hurt over now.
The longer you wait to save, the harder it could be to develop the habit. Even if you can’t save a lot, save what you can. It’s like exercising. At first a strenuous workout can make your muscles sore. But over time, your body gets used to the exertion. But each time you stop, you have to get used to exercising again.
It’s the same with retirement savings. It might hurt now, but the more you do it, the more routine it becomes.
There’s a well-being component, too:
“Young adults who are saving are more likely to feel that they are securing their financial future, are enjoying life because of the way they are managing their money, and can handle an unexpected expense,” according to a study by the AgingWell Hub at Georgetown University and the TIAA Institute.
4. Inflation is one of retirement’s biggest risks.
Inflation reached a 40-year high of 9.1 percent in June 2022.
Inflation should worry you.
It is the No. 1 reason to save for retirement. Rising consumer prices can significantly reduce your purchasing power when you’re living on a fixed income.
5. Social Security changes are coming.
Young adults I meet with say they don’t think Social Security will be around by the time they need it.
The Old-Age and Survivors Insurance Trust Fund, which pays retirement and survivor benefits, will be unable to issue full benefits starting in 2033, according to the latest trustee reports for the Social Security and Medicare trust funds.
Although Social Security has a significant funding shortage, I have no doubt it is here to stay. Without it, millions of seniors would fall below the poverty line. But the fix could be financially painful for future generations.
Potential solutions have been discussed, including increasing the age at which the full retirement benefit can be collected. You can start receiving Social Security as early as 62. However, your benefit amount will be reduced if you start collecting before your full retirement age, which currently is 67 for those born in 1960 or later.
One idea to address the shortfall is to push the full retirement age to 70. It’s unlikely Congress will do away with Social Security, but it’s important to save now to prepare for whatever changes may come.
