Retirement won't be impossible for Generations X and Y, but compared with the baby boomers, they will need to save considerably more to make up for less employer and government help.
Fewer young people have access to generous retirement benefits, including traditional pensions and retiree health insurance. And those born in 1960 or later must wait an extra year, until age 67, to claim the full amount of Social Security they are entitled to. Those who claim at the same age their parents did will get less.
Here are some ways 20- and 30-somethings can get on track to retire comfortably:
Set a worthy goal. In a 2010 survey of 226 registered investment advisers commissioned by Scottrade Advisor Services, more than three-quarters (77%) suggested a retirement savings goal of at least $2 million for members of Generation Y, defined by the study to include those ages 18 to 26. Sixty-eight percent of the investment advisers said members of Generation X should also aim to save more than $2 million.
"For a Generation Y person who thinks she wants to retire at around age 70 who is going to have slightly above-average annual expenses, $2 million is probably the right number," says Michael Farr, the president of the Washington, D.C., investment firm Farr, Miller & Washington and the author of "A Million Is Not Enough: How to Retire With the Money You'll Need." But he cautions, "Most people who have high incomes and the ability to set aside $2 million will likely have more-expensive lifestyles."
However, other studies have found that young people may be able to get by on less in retirement. Human resources consulting firm Aon Hewitt calculated that Generation Y workers, whom it defines as people ages 18 to 30, will need 18.7 times their final pay for retirement, including Social Security, traditional pensions, and personal savings, to maintain their current standard of living after retirement at age 65. For someone whose final salary is $75,000, that's just over $1.4 million, and Social Security will provide part of that.
Aon Hewitt estimates that Generation Xers (ages 31 to 45) will need 16.1 times their final salary to pay for retirement. "A higher earner will probably continue to spend more in retirement," says Janet Tyler Johnson, a certified financial planner and president of JATAJ Wealth Management in Fitchburg, Wis. "It's really dependent on how much you need in retirement."
Take advantage of employer help. Getting to $2 million will take some effort, even if you start saving early. A 25-year-old will need to save about $7,405 annually, or $142 per week, to get there over 40 years, assuming an 8% annual return. Retirement account contributions from your employer will make it much easier to hit your retirement savings goal. If your employer matches your 401k contributions with $2,000 per year, you'll need to save only $104 per week to have $2 million by age 65, again assuming an 8% annual return.
Control costs. Minimizing investment fees and expenses will help you to grow your nest egg faster. That's because high expense ratios for mutual funds can result in a serious drag on your long-term returns. Getting a 7% annual return instead of 8% over a 40-year career (because you are paying 1% in yearly fees) means you will need to save $2,255 more per year to still hit $2 million by age 65. Index funds generally charge much less in annual fees than actively managed mutual funds do. "If I didn't manage my own money, I would buy an S&P 500 index fund because it is low-cost," says Farr.
Get a Roth IRA or 401k. Roth 401ks and IRAs allow young people, who are likely to be in a low tax bracket, to prepay taxes on their retirement savings. "Young folks are in a lower tax bracket now than they will be in the future, including when they begin to tap into their retirement savings," says Joe Alfonso, a certified financial planner for Aegis Financial Advisory in Lake Oswego, Ore. "You're giving up the current tax deduction, but you are basically getting tax-free retirement income that would otherwise be taxable in the future." Once your contribution is made with after-tax dollars, that money can continue to grow for the rest of your life without the drag of taxes. If you wait until age 59 1/2 to withdraw the money, you won't have to pay taxes on any of the growth. (Will your 401k provide enough? Find out with MSN Money's calculator.)
Maximize Social Security. Social Security provides a base level of income that your retirement savings should build upon. Take steps to maximize the amount you get by making sure you have at least 35 years of earnings under your belt before you sign up for payments, so that zeros won't be factored into your calculation. And carefully consider the age at which you begin to claim benefits. Payouts increase for each year of delayed claiming between ages 62 and 70.
Don't plan on retiring at 65. A male born in 1946 can expect to live 18 years after retirement at age 66, according to Social Security Administration projections. Men born in 1980 should plan for at least a 19.3-year retirement, after the higher retirement age of 67. For women, the average projected length of retirement jumps from 20 years for those born in 1946 to 21.2 years for those born in 1980. And these are just the averages. "Generation Y's life expectancy is going to be a lot longer," says Farr. "They have to fund more years of retirement than the old financial planning models built in."
Of course, you don't have to retire at age 65, or at what the Social Security Administration defines as the full retirement age, which is 66 for most baby boomers and 67 for younger people. Working a few extra years gives you more time to save, allows your investments more time to compound and reduces the number of retirement years your savings must finance. If you're 25 now, and willing to work until age 70, you could reach $2 million by saving just $95 per week, assuming an 8% annual return and not even counting the 401k match.
Don't get hung up on the number. How much you need to save for retirement largely depends on your expenses. If you're willing to pay off your mortgage before retirement, move to a smaller house or low-cost area of the country, and live a modest lifestyle, you may find a way to get by on less. Conversely, those who want a lavish retirement will need to save more.
"If you've got a goal based upon assumptions about inflation and rates of return, it's actually counterproductive, because those numbers can be pretty big, especially for young folks," says Alfonso. "It's more important to focus on the things that you can control, such as the percent of your gross income that you save, and to really focus on your career and moving up the salary chain."
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