If you’re in your early 20s, you might be struggling with a common financial planning question: Should you be saving money for retirement, or should you first pay off your debts, specifically your student loans?
Of course, the answer to this question could vary depending on your individual circumstance. Still, we discussed this conundrum with Andy Smith, Senior Vice President of Financial Planning with Financial Engines and co-host of the Financial Engines Investing Sense radio show. Here’s what he had to say.
Save for retirement. What’s the next question? Just kidding. Seriously, though, you absolutely should be saving as much as you can for as long as you can.
Consider this scenario:
Maria and Connor are 27-years-olds who work for the same company. Maria immediately started saving $300 a month in her 401(k). Connor started saving $300 a month in his 401(k) starting at age 37. They both saw 6% annual returns over their investing lifetimes and reinvested all their earnings.
But at age 67, Maria had over $250,000 more in savings than Connor because she saved earlier and could take advantage of the power of compounding interest (assuming a $1,000 starting balance and all earnings reinvested in the tax-deferred account. Remember, you’ll have to pay taxes when the money is distributed, and your annual returns could be lower or even higher.)
Those first 10 years when Maria was saving were worth nearly twice as much as Connor’s total investments.
This means that if you start early, you’re putting yourself in a situation where you could have a lot more money than if you wait. So, don’t wait.
If you have a job where your employer offers a 401(k) (or any type of retirement-savings account), enroll in the 401(k) today. Try to save 10% of your income. If 10% is too much, shoot for 5%, but at least try to save enough to get the full employer match on what you save (many employers provide a match up to a certain percentage of pay; I’ll touch on that below). And if any of that just isn’t possible, save 1%.
1% may sound silly, but it’s not. Even if you start small and increase your contributions by just 1% each year with an auto-escalation feature (up to 10%), you could end up with a sizable 401(k) over time. Want proof? At the end of 20 years of saving, it would mean the difference between having around $65,000 in your account versus having nearly $171,000, almost a $105,000 difference.
$105,000 isn’t anything to sneeze at. Saving money in your 401(k) is always a smart move.
Now, about an employer matching contribution: This is just the amount of money your company chooses to put into your retirement savings account on your behalf as you participate in its plan (at least up to a certain amount). These matching dollars are in addition to any of your salary-deferral contributions.
Again, you should be trying to save enough to get the full employer match on your contributions. A surprising number of people, sadly, don’t even do that. Financial Engines studied the saving records of 4.4 million retirement plan participants at 553 companies, and we found that 25% of employees miss out on receiving the full company 401(k) match by not saving enough.
That’s right: People don’t even save the bare minimum to get more money from their employer. The result is that people are basically leaving an average of $1,336 on the table each year, or roughly 2.4% of extra annual income. Plus, with compounding, this money people are leaving on the table could amount to as much as $42,855 over 20 years.
For most people, that question about whether to save or pay down your student loans has an easy answer. Don’t walk away from $105,000 by not starting to save today. And don’t walk away from possibly another $42,000 over your lifetime by not taking advantage of your employer 401(k) match.
The bottom line?
Start saving and investing as much as you can for as long as you can. Your future self will thank you and will think your current self was a financial genius.
Featured Image Credit: Pexels.