How to start planning for retirement at age 25

In this post, I'm talking about how to start planning for retirement at age 25. So if you're starting your retirement planning.  We have you covered. And if you're looking for the basics in retirement planning, you've come to the right place.

Table of Contents

    Why Age 25?

    Age 25 is a starting point. It's the beginning of your life, your retirement planning life, to save for your retirement. It doesn't matter if you're 20 or 30 years old. Maybe I should have written the title to say, "20 somethings," or "How to start planning for retirement," but I chose age 25, and that's that and so let's continue.

    So you're 25 years old, and you have this massive runway in front of you and an opportunity you need to seize.  That opportunity is saving for your future, but you might not realize that starting early means you can save less and get to the same point for retirement.

    That's the opportunity.  Start early and save less.  Or, start early and save more and be richer.  You choose.

    Either way, you need to save, so seize it.  It is not an option.

    It's something that you need to do, and it's going to open up more doors later on down the road. It will give you the stability to make the decisions you want to make. So whether retirement is not working or financial independence, it's the same thing; you need to do it.

    And that is the reason why I'm using these concepts in these strategies for this post.

    This is for somebody that's 25 years old and not someone closer to retirement because we're not going to talk a lot about what retirement will look like because the truth of the matter is you probably have no idea what you want your retirement to look like.

    So I want to give you the tools and the strategies to get that retirement plan ball rolling. But still, keep those doors open for you and give you as much financial independence as possible at the age of 25. So let's go ahead and get started.

    The Roth IRA Explained

    Let's start with the first strategy or type of account: the Roth IRA.

    Now here's how the Roth IRA works. It's going to come from your checking or your savings account because it's already taxed, and it's going to go into this individual retirement account, IRA. And in this type of account, an IRA, you're going to contribute.

    You put the money into the Roth IRA, and you can invest it in anything like stocks, bonds, mutual funds, or ETFs.

    Now, over time, hopefully, this money's going to grow. And that growth and the contributions in retirement will come out tax-free, and that growth in the tax-free dollars is why so many people talk about the Roth IRA and why so many people love the Roth IRA because you're getting all that tax-free growth.

    The contributions can come out any time, so what does that mean?

    The Roth IRA is flexible. So if you contribute to the Roth IRA realize that you need that money, you could take it out a day, a week, a month, a year later. There is no time limit on it, and you can take it out for any reason. That is your contribution. The growth needs to stay in there until retirement.

    There are many other reasons or ways you can take the money out of the Roth IRA early, and that is for a first-time home purchase or education planning or the contributions for just about anything. But here's the deal. Leave the money in the Roth IRA. Please don't touch it. It should be an absolute last resort that you would take a dollar out of the Roth IRA before retirement.

    So we talk about the Roth IRA a lot on the Youtube channel. And a lot in the industry that the Roth IRA is more or less like the Swiss Army knife of retirement plans because it could do so much. But the truth of the matter is if you want to maximize the Roth IRA, keep the money in there, keep it growing, keep it working harder for you over time.

    Now, you can put up to $6,000 into the Roth IRA when it comes to the Roth IRA. And here is a breakdown of how the contributions into the Roth IRA can be made. So if you did it yearly, you could do up to $6,000. But if you broke it down monthly, that would be $500 if you did it weekly, $115.38, or daily at $16.44.

    Now, I wanted to show you that you can understand how much you need to set aside to maximize your Roth IRA, but even at $6,000, it's probably not enough for you to reach your retirement planning goals. So while the Roth IRA is an excellent savings vehicle, it's not going to solve all of your retirement planning needs.

    So let's go ahead and look at why that is and what it would look like over time.

    Roth IRA Start saving at age 25

    So if we make these contributions starting at age 25 at $6,000 every year, we want to check to see how much money we're going to have at age 50, 60, and 70 to show you how this works.

    Now, I will use a $6,000 contribution each year for this example. But we're going to break that down monthly because that's the most likely way that you're probably going to save almost every single person that I know saves monthly or per paycheck.

    One of those two is usually how we're putting money into these accounts.

    So for the Roth IRA, we will make a $500 contribution for 25 years age 25 up to age 50. And let's go ahead and start there, and I'm going to show you what this math looks like. If I break out our calculator, we have first to go 25 years, and then we're going to have to assume a rate of return. We can look at the rate of return by looking at this matrix chart of the S&P 500.

    It may look complicated but don't worry; it's not.

    If we scroll down, all I want to show you on this chart is how the S&P 500 has done from 1926 to 2020. The point of showing you this is to show what a reasonable expectation of a rate of return is over a long time. And this is the S&P 500, and it captures roughly eight percent of the market.

    It's the most widely used metric for performance in the stock market with the S&P 500. So let's assume a 10.3% rate of return every single year. Let's go ahead and pull this up on this screen here, and we can see that we are going to say for 25 years at 10.3%, we have nothing save today, but we're going to make $500 contributions each month for the next 25 years. And that will work out to $704,000.

    Now, I'm going to round here just to we can do some easy math, but I'm going to rate 704,000. And then let's bump that up to age 60, so that's 35 years. And that's going to work out to 2 million, 69,271. Then let's just put this in as 2.1 million, And then we will go from age 70. Taking age 70 would be 45 years of total retirement savings. Forty-five years, that's going to give us $5.9 million.

    We can come back in and add more numbers to this later on. Here, we'll do $6,000 per year to age 50, which comes to $740,000.

    But there's a bit of a problem there.

    And that problem is $740,000 for 25 years is not going to be worth $740,000. It's going to be worth less but not worthless.

    How do you figure that out?  We have to look at inflation. So if we take this $704,000 and bring it back to today's dollars, we have to discount it.

    Don't worry. The big term, "discounting," for 3%, and I'm choosing 3% for inflation, which is one of the causes of why prices increase over time. So while you're going out and spending a dollar on that same gallon of milk today, it will not get you as much milk tomorrow, or you'll need to have more money. That is why inflation is so important to look at.

    But we don't feel it because it slowly creeps in overtime.

    If we go back to our original example and figure out how much that will be, that will be our $704,000. And if we reduce this down by 3%, what is that today?

    That's going to be the equivalent of $333,000. I'm just going to write $333,000 because this is today. This is what we're looking at for today.

    Roth IRA saving for longer periods (getting richer)

    Let's go ahead and do the same for 35 years or age 60.

    So what is that going to look like?

    If I put a zero there and put $500 back there, which will be 10.3% there, that will be our $2,069,271, and we could do the same thing. We can zero the rate of return out, and we can input it at 3% for inflation. That is going to be $725,000. Then we can look at the final number, which was 45 years at 10.3%, and we have nothing saved today. $500. That is going to be 45 years.

    Saving over 45 years rather than only 25 years jumps to a total savings of $5,875,840—the same thing we can be discounted back at 3%, which will be $1,525,822.76. So let's go ahead and write that out quickly.

    And you don't need to know precisely how to do all of this math.

    You can estimate exactly how much you need to start saving if you're getting comfortable with retirement planning. That's $1,525,822 when we discount %5,875,840.  Again, $5,875840 in 45 years is worth $1,525,822 in today's dollars. You can see that we need to boost our savings to outpace inflation and have enough in retirement. It almost seems unfathomable how much $5.8 million is in today's dollars. So it's not quite as rosy as we originally had thought.

    A rule of thumb would be that you could live on roughly four to 5% of your total nest egg. You'll see reports saying you can't do that because of longer retirements. But there are a lot of other problems of retiring early, such as not getting Social Security and then having to dip into your retirement plan and not having those years where you're earning more money.

    We're going to leave that off to the side because I want to get you set up correctly so you can start to save and get on track. Let me talk about one other point about the Roth IRA before moving on to the next type of retirement plan you need to save into.

    That is the income limit.

    Roth IRA Income Limits

    So if we're taking a look at the income limits here for the Roth IRA, if you're filing your taxes as single or head of household and you make a $125,000 or less, you can make that total $6,000 contribution.

    But if it's over $124,999 or $125,000 or greater, it's going to be a reduced amount, possibly zero. If it's over $125,000, it begins to phase out. This means a reduced amount of that $6,000 as you get closer to the $140,000 mark, then you can't contribute directly into the Roth IRA.

    We're not going to talk about it in this post. I do have blog posts and videos on phase-outs.

    Same thing for Married filing jointly that is going to go from $198,000 to $208,000. For Married filing jointly, that is your combined incomes for you and your spouse. It's not just your income. It's also inclusive of your spouse's income.

    Just food for thought if you're married, filing jointly for the first time or something like that.

    Roth IRA + Traditional IRA + Workplace Plans

    You need to understand that it's combined for the Traditional IRA and Roth IRA. The income phase out goes from $198,000 to $208,000 for 2021. The numbers for single filers go up to $129,000 to $144,000 in 2022. And Married filing jointly income phases out from $204,000 to $214,000.

    The next type of retirement plan that I want to talk about is your workplace plan.

    This could take on 401(k), 403(b) or Thrift Savings Plans too. This is really important that you're making these contributions into your retirement plan at work for a variety of reasons.

    First, you need to save for your retirement planning.

    Second, you have a match at work. Now that match is basically free money. If you don't make the contribution and you have a match, you're not going to get it. So it's really important that you make that contribution into your retirement plan to at least get the match. But from the numbers that you saw before, you're likely going to need to save even more than just a match.

    As soon as you can get it up to ten, 15 or 20% or even more, depending on how much money you want in retirement. The math is going to work exactly the same as I just showed you, that you're going to make this contribution. You're going to have a projection on how much, which is just an estimate, an estimate on how much you can or you can earn in your account each and every single year.

    We use the S&P 500 just to give us some direction but you could be a little bit more conservative and use lower numbers like 9% or 8%, seven or six percent. But all these numbers are going to be much smaller. Doesn't mean that's how you're going to end up.  But having the right projections match with the right investments means you're going to reach your goal.

    Think about it just like anything else you've ever done. If you have a goal, you have a plan, but you don't execute on it. You're not to reach the goal. But if you have that goal, you have that plan and you do execute. You're going to have a lot higher chance of reaching that goal, but it's not guaranteed. Same thing with your retirement plan, something that you need to constantly revisit.

    Not necessarily make changes but revisit and make tweaks, possibly save even more to reach the goal. That is a little bit on two separate types of accounts, the Roth side and your retirement plan at work.

    Now, the retirement plan at work could have a Roth side to it, which I haven't talked about. But generally when I'm talking about a retirement plan at work, it goes in pretax.

    Now we have an aftertax account, which is the Roth and then we have a pretax account, which is your retirement plan at work. That's what we're talking about right now. Let's go ahead and compare the two, so you can understand the balance.

    And that is a key right there. The balance between these two types of accounts. So, let's talk about how they work together and talk about how they are taxed. If we look at this page right here, I have written out our paycheck of a Roth IRA. This is going to be an after tax dollar.

    That means you're going to get this paycheck of a dollar. It's going to get taxed in this assumption, I'm assuming a 12% tax bracket.

    Which also means $0.12 on the dollar are going to be withheld. So that means you're left with $0.88 This goes into your checking account. From your checking account, you can make the contribution into the retirement plan.

    If you remember before this illustration, right here, checking account into the Roth IRA, that's where we are right here. Go from the checking account and making that contribution. That's my short for contribution.

    And you're going to make that full 88 cent contribution. Then you're going to get a rate of return or zero are. This is how well you're performing and we're going to double our money over time, whether it's 5, 10, 15 years, it doesn't matter. It's just an illustration.

    If we double this $0.88 with this investment it will be $1.76 when we take the money out in retirement as a distribution. It will not be taxed because it comes out tax free in retirement. It's going to be a $1.76.

    Now, let's compare this to the pretax type of account.

    Our $1 in our paycheck doesn't get taxed at the federal level. That means it skips all of this and it goes directly into the account and our contribution is the full $1.

    So you get to take what would have been is $0.12 and you get to keep it inside of the account. Now, let's just compare the taxation of these accounts. If we look at this and we use the same investment, it would double because it's the same investment. You get the same rate of return so that $1 would then work out to be $2. But assuming we are in the same tax bracket, when we pull it out in retirement, that $2 will be taxed at 12%.

    That means we're going to be left with $1.76, which is exactly the same as the Roth IRA. So for most 25 year olds, the Roth IRA and the Roth side of the retirement plan at work is going to seem like the way to go.

    But the real question is how do you make that decision?

    You want to look at things like your credits and your deductions. Whether or not you would qualify for either a credit or a deduction would be dependent on your income. You need to kind of have some forethought, some planning involved when you're making that decision. It's going to be dependent on your family size; if you're married, filing jointly, single, head of household, whether or not you have kids now or whether or not you're going to get a raise or a bonus.

    There are a ton of things that are going to go into the decision of whether or not you should put into the pretax or the post-tax, the 401k, the traditional side or the Roth 401k and credits and deductions.

    The name of the game is to smooth your taxes over time. And that is what that illustration showed when we're making that decision, because we were assuming that we're in that 12% tax bracket today, but also tomorrow. But that's not always the case because if we look at these tax brackets here, we could see that over time they increase.

    If you're single and you earn more money, the more money you make, the higher your tax bracket goes.

    If you're in the 24% tax bracket and you're making $90,000, it might make sense to put in a little pretax money so you don't have to pay any of the 24% tax bracket and just jump into the 22% tax bracket. But this gets magnified if you have certain credits or deductions because it's in addition to your federal taxation. It does get a little complicated, but if you take a step back, look where your income could possibly fall. See if there's any credits or deductions that are pretty close.

    And then you can help make that decision or start to make that decision and where you should put those retirement planning dollars.

    Solo 401k for the self employed

    There is a third type of account that is for the self-employed, independent contractor, or if you have a side hustle, you could possibly qualify. And that is the solo 401k.

    The reason I want to throw it into this mix, if you don't have a W-2 job, you own your own business.

    This could be a great option. But even if you have a W-2 job and you just want to save more then if you have a side hustle, then you could possibly qualify to open up a solo 401k and get even more money into your retirement plans.

    The solo 401k, the reason you would want a solo 401k, even if you have a retirement plan at work, is that you have the flexibility of giving, getting even more money into your retirement plan.

    You can only put up to $19,500 for 2021 or $20,500 for 2022, as the employee into your retirement plan at work in addition to a match. Depending on your plan, you might be able to make a nondeductible contribution to get it up to the maximum.  The absolute maximum of $58,000 for 2021 or $61,000 for 2022.

    401k Limits 2022

    401k Limits 2022


    That's a separate $6,000 that will actually aggregate with the traditional IRA. But let's stick to the basics right here for the 401K and the solo 401k, which would be combined. For example, as an employee, if you put in $10,000 into your 401k at work then you can only put in $9,500 into your solo 401k as an employee.  Not including the match or profit sharing contributions.

    You can get a little bit more into that retirement plan.

    Plus as a self-employed independent contractor, somebody with a side hustle, if you open up that solo 401k, you can make up to a 25% matching contribution, also known as a profit sharing contribution for the solo 401k, but it's going to give you a little bit more of an edge for your retirement planning gold, which you can see by the math, is so important.

    The longer time frame that you have and the more that you're saving, the better off you're going to be when it comes to your retirement plan. It's really important that you take action on this stuff and start to save into the rough start to save into your retirement plan at work.

    And if you need to do more, go out and get a side hustle.

    If you don't already have one, earn a little bit more and put it away because that's going to help boost your retirement plans significantly versus obviously not doing that.

    Finding Financial Balance in your Life

    Now, here's where we're going to change the mindset.

    So tip number one to improving your success is finding balance.

    So everything I talked about was just focus on saving for your retirement, and that's great.  If you're super excited about getting on track, go ahead and start saving and get the money into the Roth IRA or 401k's and get that ball moving.

    But you need to find balance and that means you need to make sure that you have a cash reserve, making sure that your insurance, such as your income protection, also known as a disability policy, is in place along with life insurance. The other insurances, such as auto insurance are usually required but you should still review them to make sure you have the right amount and type of coverage.  Not all policies are equal.

    All these are areas you need to take care of because if you can't afford the insurance, building a cash reserve or pay the bills, then there's no sense in saving for retirement.  You will have to turn around and cash it out immediately to make ends meet and if that is you then stop because that will cost you more in penalties and headaches.

    So find balance.

    And again, if you need to go back to that step I talked about before, where you get a side hustle then maybe you can save more by earning more. If that's what you need to do, then do it.

    So number one, find balance.

    Speed of your Retirement Plan Expectations

    The second thing that we want to talk about is the speed. Understand that things don't happen really fast. You need to start making those contributions.

    So even if you looked at these numbers before and you thought, you know what, $1.5 million, that seems like a lot of money when I have nothing saved or $5.8 million, that is a ton of money, especially when you're starting at zero.

    You might be asking yourself, how am I supposed to get there saving just $500? But just understand, the speed of things don't happen quite as fast as you think.

    You live on an Island when it comes to retirement planning success

    Now, the third point is understand one of the most important concepts of these three tips, and that's understanding that you live on an island.

    You cannot keep up with the Jones'!

    Don't even try.

    There's a good chance most of your friends and family are living above their means. They're spending more than they're earning or they're not saving enough. They're not balanced.

    Understand, that if you're looking at somebody who has a similar job and you're looking at their lifestyle, chances are they're living a higher lifestyle than they're actually earning.  Meaning they're probably not saving enough money for retirement.

    You have to be comfortable living like nobody else, on an island by yourself, in a clear and realistic mental state.

    I know that's super difficult for so many people to do it because they're like, Well, I earned this and I know this person earns that and they're doing this or that. And I might not be able to do anything.

    Well, if you want to do those things, you got to go out there and earn more money or get a side hustle or change something that will allow you to do what you're trying to do.

    But you've got to find the balance.

    You've got to control the speed, and you got to understand that you can't keep up with the Jones', that you live on an island. If you can start to do that, you're going to greatly improve your chances of reaching your retirement planning goals and not have so much stress.

    And that's really, really important.

    Retirement Planning Mindset #1

    Which brings me to the last and what I would think is the most important part of retirement planning, investing and just living a financially responsible life.

    And that is patience. Patience is the number one key to reaching your retirement planning goals.  It is not complicated. You don't need the next hot stock Tip of the day. You don't need the ultimate trading strategy. You just don't need any of that. You can make a lot of minor tweaks to your retirement plan.  But the truth of the matter is it comes down to patience.  The real key that so many financial plans fail because we're not applying patience. And I told you I would prove to you that patience pays off, and that is super valuable.

    Now, I'm going to direct it to another video.

    In this video I did a couple of weeks ago on performance, and I'm going to give you the rundown on it; then you can go ahead and watch the video. But in the video, we took five accounts over a decade and we looked at the performance, and this is money that we manage that my firm manages.

    And we started with $300,000 (rounding) and we contributed $2.5 million (rounding) to these accounts or the accounts that we were taking a look at made contributions of $2.5 million among all the accounts over a decade, and that resulted in a $19.7 million gain and those accounts made $19.7 million.

    That is incredible performance relative to the S&P 500 and it beat it handily over that time frame.

    And the one attribute was patience.

    We weren't buying and selling a lot over that decade, and we probably won't do a lot of buying and selling over the next decade. It is taking the time to understand your retirement plan and when the timing is right to make those decisions. If you know what you need to do each and every month, you make that contribution into the Roth IRA or make that contribution into your retirement plan at work, or earn a little bit of extra money on the side.

    It has a tremendous impact on your ability to reach your goals at the end of the day.

    And I wanted to use that example because it's there bigger numbers than most people are used to. A lot of people talk about getting good rates of return, but they're usually talking about like $500 or like, I bought a stock and it tripled.

    Okay. How much money did you have in there?

    And they're like, "Well, $500. That's not going to really move the needle."

    But over time, if you continue to apply those concepts it equals a lot. And that's where we get $300,000, make a $2.5 million dollar contribution. So roughly $2.8 - $3 million into $20 - $23 million. That is a significant change in those lives of those accounts, and it was really attributable to patients.

    So it all comes back to it.

    We're not talking about patients for like a week or a month or even a year. We're talking about patients year after year because if you look at the starting point and you look at the ending point and the math that I just showed you with 10.3%.

    Guess what, 10.3% is not going to happen every single year. Even if you hit 10.3%, you mean it was nine or if it was 8%, you're not going to hit that every single year, even though that's how we run the math and the projections. So for coming back to that, we're not necessarily off track. We're at 10.3% every single year. It's about conceptually understanding that over time, that's what we're going to hit. We're going to have great years and we're going to have down years and possibly some more years in there.

    Maybe there's a recession in there.

    Maybe there's two or three, I don't know.

    But if you're applying patients you're going to increase your chances of reaching your retirement plan and goal success. So right off the bat, a couple of strategies on what you can do to improve your retirement plan, both with types of accounts and how you're thinking about your retirement plan. Let me know in the comments on the youtube channel with any questions about starting your retirement plan at age 25.

    And I will do more posts and videos on this.