Retirement Plans for Young Adults

Young adults have many priorities, from advancing their careers to planning for a family, which often leads to saving for retirement being placed on the back burner. However, being a young adult offers a significant advantage when it comes to building wealth for retirement due to the advantage of time. The power of compound interest can have remarkable effects over the long term, allowing even small amounts saved now to yield substantial rewards in the future. Fortunately, there are several retirement plans for young adults to put their money to work.

Do you have questions about how to get a retirement plan started? Speak with a financial advisor today.

Retirement Plan Options for Young Adults

Retirement plans are crucial for individuals to secure their financial future and build a comfortable retirement. Here are the pros and cons of each of the retirement plans available:

Defined Contribution Plans

Defined contribution plans are employer-sponsored retirement plans that have largely taken the place of pensions in the last several decades. The most commonly found defined contribution plan in the private sector is the 401(k), with the 403(b) functioning similarly in the nonprofit space.

Pros:

Portability: These plans are typically tied to the individual, making it easy to transfer and continue contributions when changing jobs.
Investment control: Individuals can choose how to invest their contributions from various funds and indexes, potentially leading to higher returns.
Employer contributions: Many employers match a portion of the employee’s contributions, providing “free” money to boost retirement savings.
Tax advantages: Contributions are usually made with pre-tax money, reducing current taxable income.
Contribution limit: Employees can contribute $23,000 annually to this plan in 2024, more than triple the limit for IRA contributions.

Cons:

Market risk: The performance of investments directly impacts the account value and fluctuations in the market can lead to potential losses.
Responsibility for investment decisions: Individuals bear the responsibility of managing their investments, which can become overwhelming, especially for those with limited knowledge in the realm of investing.
No guaranteed income: The final retirement income depends on the performance of the investments. On the other hand, pensions guarantee income for the rest of your life.
Limited options: Unlike a brokerage account, 401(k)s have a select number of funds and account types. As a result, you might not be able to invest in the specific slice of the economy you think will have good returns.

Individual Retirement Account (IRA)

A young couple looking for the best retirement plans

Traditional and Roth IRAs

An Individual Retirement Account (IRA) allows you to set aside money for retirement regardless of employment circumstances. There are several types of IRAs. First are traditional IRAs and Roth IRAs. Contributions to a Traditional IRA are tax-deductible, reducing your taxable income for the contribution year. The funds grow tax-deferred, meaning you pay taxes when you withdraw funds during retirement. On the other hand, you contribute to a Roth IRA with after-tax money, so there’s no immediate tax deduction. However, the earnings and withdrawals in retirement are entirely tax-free.

Spousal IRA

Next, a Spousal IRA comes in traditional and Roth varieties and allows couples to save when one spouse has little or no earned income. It allows the non-working or lower-earning spouse to contribute to an IRA and benefit from tax-advantaged retirement savings. The working spouse must have enough earned income to cover their own IRA contributions and the contributions to the Spousal IRA.

SEP IRA

Additionally, a SEP IRA (Simplified Employee Pension IRA) allows self-employed individuals, small business owners and their employees to invest for retirement. SEP IRAs typically have higher contribution limits: in 2024, you can contribute 25% of your annual pay or $69,000, whichever is less. Plus, employees become fully vested in the fund without contributing to the plan.

SIMPLE IRA

A SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) is another retirement plan option primarily suited for small businesses and self-employed individuals. It’s usually easy to administer and affordable for employers, encouraging employee participation through employer contributions. SIMPLE IRAs have lower contribution limits than SEP IRAs but higher than Traditional and Roth IRAs. Employees can make salary-deferral contributions up to a certain percentage of their compensation.

Pros:

Tax advantages: Traditional IRAs offer tax-deferred growth, while Roth IRAs provide tax-free withdrawals in retirement. So, you can reduce your tax burden while working or during retirement, depending on your chosen type.
Rollover functionality: You can roll a 401(k) or an old IRA into a new IRA, allowing continued investment without losing any funds. Remember, switching account types can have tax implications, such as rolling a traditional IRA into a Roth.
Investment flexibility: IRAs offer various investment options to suit individual risk preferences.
Additional savings: Individuals can contribute to an IRA in addition to employer-sponsored plans, allowing for greater savings potential.

Cons:

Contribution limits: IRAs have annual contribution limits, which may restrict higher-income earners from maximizing their retirement savings. Specifically, you can contribute $7,000 to your IRA in 2024.
Early withdrawal penalties: Withdrawals made before age 59½ are usually subject to taxes and penalties, discouraging early access to funds.
No employer contributions: Unlike employer-sponsored plans, IRAs do not come with matching contributions.
Required Minimum Distributions (RMDs): Traditional IRAs require you to start taking RMDs once you reach age 73. As a result, you must begin taking distributions from the account upon turning 73 even if you don’t need them, leading to higher tax liabilities.

Solo 401(k) Plan

A solo 401(k) allows business owners and their spouses to save for retirement. As the sole employee of your company, you can contribute $23,000 in 2024. In addition, as the business owner, you can contribute another 25% of your compensation (maxing out at $69,000).

Pros:

High contribution limits: Solo 401(k)s allow for heftier contributions than traditional IRAs, enabling more retirement savings for self-employed individuals.
Employer and employee contributions: Self-employed individuals can contribute both as an employer and an employee, further boosting retirement savings.
Investment control: As with other defined contribution plans, you decide which funds get your investment money.

Cons:

Limited to self-employed individuals: As the name suggests, a solo 401(k) is for self-employed individuals with no employees. You’ll have to shutter the plan if you hire a worker for your company.
Administrative responsibilities: Managing a solo 401(k) involves additional administrative tasks and potential costs compared to other retirement plans.

Traditional Pensions

A traditional pension is an employer-sponsored retirement plan that guarantees a specific amount of income to employees during their retirement based on factors like years of service and final salary. Employers fund the plan and employees typically don’t contribute directly. Pensions offer a guaranteed income for life and relieve employees from making investment decisions. However, they have become less common as employers shift to defined contribution plans like 401(k)s.

Pros:

Guaranteed income: Traditional pensions provide a predictable stream of income in retirement, usually based on years of service and salary.
No investment risk: The employer manages the investments and assumes the market risk.
Lifetime benefits: Pensions often offer benefits for life, ensuring financial security throughout retirement.

Cons:

Declining availability: Traditional pensions are becoming rarer in the private sector, with many companies shifting towards defined contribution plans.
Limited control: Employees have little control over the pension plan’s management and investment decisions.
Vesting requirements: Employees may need to work for a certain number of years before they become eligible to receive pension benefits.
Funding issues: Pension funds can fail, reducing your income level during retirement.

Guaranteed Income Annuities (GIAs)

Guaranteed income annuities (GIAs) provide a predictable income stream for a specified period or the rest of your life. You purchase an annuity from an insurance company, creating a contract between yourself and the corporation. While you work, you’ll pay installments to the insurance company and in return, the insurance company promises to provide regular income payments in the future.

Pros:

Lifetime income: GIAs provide a guaranteed income stream for life, protecting against the risk of outliving one’s savings.
Predictable returns: The income generated by GIAs is not subject to market fluctuations, providing stability in retirement.
Tax advantages: Some annuities offer tax-deferred growth, which can benefit retirement savings.

Cons:

Irreversibility: Annuities are typically irreversible once purchased, which means the funds used to buy the annuity are no longer accessible in a lump sum.
Limited liquidity: Annuities may restrict withdrawals during the accumulation phase, limiting access to funds if needed.
Fees and commissions: Some annuities come with high fees and commissions, potentially reducing the overall returns.

The Federal Thrift Savings Plan (TSP)

The Federal Thrift Savings Plan (TSP) is a retirement savings plan for US federal government employees and members of the uniformed services, including the military. It is one of the largest defined contribution retirement plans in the world and operates similarly to a 401(k) plan in the private sector.

Pros:

Low fees: The TSP is known for its low administrative and investment fees. Specifically, you’ll pay 0.0004% of your account balance. This figure is exponentially lower than other account types, which range between 0.5% and 2%.
Employer matching: You receive an annual 5% employer contribution, which includes a 1 percent non-elective contribution. Plus, your employer matches all of your contributions up to 3% of your salary and half of your contributions for the next 2%.
Contribution flexibility: You can make pre- or post-tax contributions, simulating the effect of a traditional or Roth account.
Various investment options: The TSP offers a range of investment funds with different risk profiles, allowing participants to diversify their portfolios. Options include the S&P 500 index, which has provided an average annualized return of over 11% since its inception.

Cons:

Limited to federal employees: The TSP is exclusively available to federal government employees and uniformed service members.
Limited investment flexibility: While the TSP provides multiple investment options, the choices might not be as extensive as some other retirement plans.

How Young Adults Can Boost Retirement Savings

Being proactive about retirement savings is crucial to building a solid financial foundation. Here’s how to set yourself up for a comfortable and secure retirement in the future:

Start Now: The most critical step for young adults to boost retirement savings is to start saving as early as possible. Time is a powerful ally in building wealth through compound interest. Even small contributions made early on can grow significantly over time, providing a substantial retirement nest egg.
Allocate Funds to Your 401(k): If your employer offers a 401(k) plan, take advantage of it. Contribute as much as you can, up to the maximum the plan allows. 401(k) contributions are made with pre-tax dollars, reducing your taxable income while growing tax-deferred until retirement.
Take Advantage of Matching Contributions: If your employer offers a 401(k) match, aim to contribute at least enough to get the full matching amount. An employer match doubles your investment money for free, acting like jet fuel for your retirement savings.
Start an IRA: Consider opening an Individual Retirement Account (IRA) in addition to your 401(k). IRAs provide additional tax advantages and investment options. For example, you can establish tax diversification by having both a traditional 401(k) and a Roth IRA, giving yourself one tax deduction now and one during retirement.
Automate Your Savings: Set up automatic contributions to your retirement accounts. By automating your savings, a portion of your paycheck goes into your retirement account without any effort on your part. This setup ensures consistent contributions and helps you avoid the temptation to spend the money elsewhere.
Trim Extraneous Spending: Take a close look at your expenses and identify areas where you can cut back. In addition, if you don’t have a budget, there’s no better time than now to make one. Then, you can locate and reduce unnecessary expenses, such as eating out or impulse spending. Redirect the money saved from these cutbacks into your retirement accounts to accelerate your savings growth.

Bottom Line

An advisor explaining the best retirement plans to a young adult

Choosing a retirement account as a young adult depends on your unique circumstances and financial goals. Whether it’s a traditional IRA, Roth IRA, 401(k) or other options, maximizing contributions is key to securing a financially stable future. If you’re unsure about which retirement plan is optimal for you, consider seeking guidance from a professional, as they can provide personalized advice to help you make informed decisions for a successful financial journey.

Retirement Planning Tips

A financial advisor can help simplify your retirement planning. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Assess your progress towards your retirement goals with SmartAsset’s retirement calculator. Determine if you’re on the right track to meet your retirement aspirations.