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Even before the first paycheck from your first full-time job hits your bank account, you should be planning for the day you’ll receive your final paycheck.
You may be thinking: I just began working. Do I really need to start thinking about retirement now?
The answer is yes. It’s far better to contribute some money to your company’s 401(k) — even if it’s a seemingly trivial amount each month — than to do nothing. Don’t have a 401(k)? An individual retirement account offers some of the same advantages, but you can open one without employer sponsorship.
Not convinced about the benefits of a 401(k)? Here’s why you should contribute to one, or to another retirement savings vehicle, when you’re young — and some tips on how to do it right.
Why retirement savings matter
Trying to envision what life will be like some four decades down the road is next to impossible. There are so many unknowns, including your career trajectory, family situation and even the fate of Social Security.
But there is something easier to predict: the need to look out for yourself. Social Security probably still will exist in some form, but gone are the days when companies provided a guaranteed safety net to employees in the form of pensions. These still exist, but only in select industries.
Rather, it’s largely up to you to fund your retirement nest egg. You may strike it rich, marry your celebrity crush or win the lottery, but until then it’s a good idea to plan for a more mundane future. Time is on your side, and money you save today has decades to grow. That’s because investments compound over time, meaning you earn interest on both money you deposit and interest it accrues.
Make savings part of your budget
If you’ve recently graduated from school and are entering the workforce for the first time, your current income likely is the most you’ve ever earned — and yet, it still may not seem like enough.
“There’s certainly going to be a lot of conflicting priorities,” including paying down student loans and saving for an apartment, says Scott Thoma, an investing strategist in St. Louis with Edward Jones. “Try to assure you’re paying yourself first and allocating money for the future.”
Budgeting helps. By keeping track of what money is coming in and what’s going out, you may find an extra $50 to set aside for retirement each month. While that may not seem like much, small adjustments can make a difference over time, Thoma says.
“We have ways of finding uses for money if it’s just sitting around,” he says. “The key is to get into the habit and getting that discipline in place.”
Start with your 401(k) — but don’t necessarily stop there
Once you’re convinced it’s important to save for retirement as early as possible, it’s time to dive into some logistics. Here’s a priority list for determining which accounts to use for your savings:
Contribute the minimum to get your employer’s full match on your 401(k). This represents a return of up to 100% on your investment. Don’t pass it up.
Consider cutting costs with an IRA. Does an IRA offer lower fees than your employer-sponsored plan? If so, max out this contribution. The limit is $5,500 for people under 50 and $6,500 for people 50 and older.
Return to your 401(k) as needed. If you wish to save still more, max out your 401(k) contribution beyond your employer’s match. The maximum is $18,000 for people under 50 and $24,000 for people 50 and up.
Invest any additional retirement savings in regular taxable accounts. This is basically any investing vehicle other than a 401(k) or IRA.
» Learn more: How to open a brokerage account
You should prioritize your 401(k) plan, especially if your employer offers a match, because it offers tax breaks. They're also easy to fund; deductions can be taken directly from your paycheck. Matching programs often are structured as either a 1-for-1 match up to a certain amount or 50 cents per dollar to a specified level.
How much should you save? A good goal is 10% to 15% of your gross income. Feeling more ambitious? So long as you can afford to save more without putting yourself in debt or shortchanging of other goals (more on that below), go right ahead.
Habits developed at a young age can last a lifetime. That’s been the case for Ken Moraif, a certified financial planner at Money Matters in Plano, Texas — and it’s all thanks to some advice from his mother.
“She told me to save 20% of my gross salary — that was the rule,” he says. Some 30-plus years later, Moraif still is following that 20% savings discipline, and he now passes along the advice to others.
Choosing the right investments
Deciding how to invest your retirement savings can be exciting or overwhelming, depending on your perspective. The options are more limited within company-sponsored retirement plans than with an IRA.
Three of the most common assets you’ll encounter in a 401(k) plan are:
Stock index funds: A type of mutual fund that tracks a particular market index of individual stocks. (A mutual fund is a way to pool assets from multiple investors.) Here's more on how to invest in stocks this way.
Bonds: An investment in a government’s or company’s debt obligations
Target-date funds: A mutual fund that contains a mix of investments — stocks and bonds, namely — and that automatically rebalances over time.
There often are additional options within each type of asset, such as where the companies are located — U.S. or international, for example — or the size of the companies. Deciding on the right mix of these investments is largely personal. Your tolerance for risk, for example, might be far higher or lower than that of other investors. In general, investors who want to minimize risk should consider index funds that track broad benchmarks, such as the Standard & Poor's 500, or target-date funds.
Target-date funds offer the most hands-off approach — they're structured around a future date, such as when you’ll retire — but they may carry higher fees. If you’re looking for a more hands-on strategy, you’ll largely be deciding between stocks and bonds. Bonds are considered less risky in the short term than stocks, but you’ll also earn a lower return. Because you have decades between now and retirement, you can afford to take a riskier approach with your investments.
Regardless of what route you take, keep an eye on fees. This may sound a bit like a broken record at this point, but the reason fees matter so much is they’ll cut into your future returns.
» See the deep dive: How to set up your 401(k)
What if the market changes or you leave your job?
All this talk of growing your investments may be exciting — until circumstances change. Markets will hit rough patches throughout your career, and you may lose your job if a recession hits or your company downsizes.
Your retirement savings are meant to be locked up for decades, and that means time is on your side. Investing carries inherent risks because asset prices can fluctuate wildly, but over the long term, the market has proved profitable. You can mitigate some of the risk by ensuring your portfolio is diversified — including a variety of assets.
If you switch jobs, the money in your 401(k) is something you take with you — unlike, say, a stapler. Matching contributions may be subject to a vesting period, which varies from company to company. That means you may not be able to take all the money your employer contributed to your 401(k). If you brush up on that vesting deadline and decide you can stick it out a bit longer, you can take the full amount.
Once you’ve landed a new job, you’ll need to decide what to do with your 401(k). Your best options often are to roll it over into your new employer’s plan or into an IRA. Again, the decision often will come down to fees. Whatever you do, don’t cash out your 401(k). Not only will you incur a big tax penalty, you’ll probably be tempted to do something with it other than saving for retirement.
A word on moderation
Whether you envision working full time into your golden years or aspire to drop out of the 9-to-5 rat race a lot earlier, the steps you take now will help your dreams become reality. But retirement probably isn’t your only goal, and it’s important to be realistic about what else you’d like to save for, like buying a home, starting a family, traveling or going back to school.
The basic advice still stands: Contribute as much as possible to get the company match for your 401(k). But the key is to take a measured approach, striking a balance between short-term and long-term goals.
Being too aggressive can cost you. Don’t save more than you can for retirement if you’re simultaneously amassing high-interest credit card debt or haven’t established an emergency fund. Dipping early into your retirement account often incurs a 10% tax penalty if you’re under age 59½, unless you’re doing so for some very specific reasons allowed by the IRS.
The journey to retirement is a long one, and while someday sooner than later you should aspire to max out your 401(k) contributions, you should only do so when it makes sense within your overall financial picture.
More on retirement from NerdWallet