How to Save for Retirement in Your Twenties

Saving up money for retirement is one of the largest financial commitments that you can make in life. To fund a comfortable retirement, it is likely that you will need to accumulate hundreds of thousands, if not, millions of dollars in financial resources before leaving the workforce. In your twenties, these numbers may seem staggering due to your relatively minimal levels of cash flow. As a young adult, however, time is on your side and you stand to benefit from long-term compounding. Your retirement plan should begin with a list of well-defined life goals.

Goal Setting

Life goals provide a sense of purpose to your retirement plan. Perhaps you dream of retiring to the Oregon Coast -- for its natural beauty and daily rounds of summertime golf. You will define your goals further, in terms of time frame and total costs. For your Oregon retirement, you may need to amass $3 million worth of savings within the next 40 years. Be sure to adjust your total costs for the inflation rate, which the Bureau of Labor Statistics pegs at 3 percent per year through its Consumer Price Index.

Financial Calculator

With a list of life goals in hand, you will pull up a financial calculator to toggle through projections. The financial calculator helps you to work through different variables for rate of return, time frame, and size of investment. After using the financial calculator, you can determine the amount of money you need to be saving each month at a projected rate of return to meet your goals. At this point, you will review your personal finances to determine whether your goals are actually realistic. If your goals appear to be out of reach, you may need to put in more time at work or sharply reduce your current expenses to unlock additional cash flow that can be saved into retirement accounts.

Retirement Accounts

As a twenty-something saver, you should make it a priority to put money into 401(k) and Roth IRA retirement accounts. 401(k) and Roth IRAs both provide for tax-deferral, which means that investment profits are not taxed as they occur within each account. Through work, you fund a 401(k) plan with tax-deductible contributions. At retirement, your 401(k) plan withdrawals will therefore be taxed as ordinary income. Alternatively, a Roth IRA is the mirror image of the 401(k) plan. Roth IRA contributions are made with after-tax money, which provides for tax-free withdrawals upon retirement. For the 2011 tax year, you may generally make $16,500 and $5,000 worth of annual 401(k) and Roth IRA contributions as a twenty-something investor.

As a young saver, a Roth IRA is particularly attractive for its tax-free withdrawals because it is likely that you will retire within a higher tax bracket than at present. Meanwhile, a 401(k) plan provides for free money -- due to matching. As part of your benefits package, your employer will match your 401(k) contributions on a dollar-for-dollar basis up until a certain point. As a twenty-something investor, you should aggressively take advantage of the 401(k) match, while also setting aside cash into your Roth IRA.

Taxable Brokerage Accounts

You generally cannot take withdrawals out of your retirement accounts until after age 59 ½ -- without a 10 percent additional tax penalty. In cases of disability, the IRS does allow you to bypass the 10 percent penalty for early retirement account withdrawals. Be advised that the IRS defines disability as a permanent condition that disallows you from working any job. For greater flexibility, you will supplement your retirement accounts with regular taxable brokerage accounts. With a taxable brokerage account, you can withdraw money at any time -- without penalty.

Investment Choices

As a young investor, you should invest aggressively because you are afforded with plenty of time to recover from losses. For your 401(k) and Roth IRA accounts, you may choose from a selection of large, mid, and small capitalization stock funds. For further diversification, you may also consider putting money into international stock and high-yield bond funds. You will increase your exposure to government bonds, money market assets, and fixed income securities as you age and near retirement.

How to Save for Retirement in Your Twenties, Sources:

IRS: 401(k) Resource Guide

IRS: Roth IRAs

SEC: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing

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