How much money are you putting into retirement savings accounts? If your answer is "none," you're making a big mistake. You cannot live on Social Security alone in your later years, and most people don't have pensions, so you have only yourself to rely on when it comes to saving for a secure future.
Finding spare cash to save for when you're a senior can be really difficult, especially if you have a lot of pressing financial obligations today. But no matter what else you're doing with your money now, you should open up a retirement account today and start putting at least some money aside.
1. Compound interest can start working for you
Most of us work hard for our money. But when you invest for retirement, you can actually make your money work hard for you -- thanks to the magic of compound interest.
When you invest money for retirement, the cash you've put into stocks or other investments can earn a return-on-investment. If you've invested in a diversified mix of stocks, you can reasonably expect an average return of around 7% to 8% annually, based on historical averages. As your money earns money, that additional cash becomes part of your investment account and can be reinvested in income-producing assets as well.
Here's a simple example. You invest $1,000 and earn 8% annually, which compounds monthly. This means the money you've earned during the first month is added to your initial $1,000, and the money you earn in each subsequent month is also added onto your new balance.
At the end of the year, you won't have just $1,080 -- you'll have $1,083. That happens because your balance grows by a little bit every month, so the next month you earn a return-on-investment on a slightly higher balance. At the end of the first month, for example, you'd have already earned $6.67 in interest. So in month two, you'd be earning interest not on $1,000 but on $1,006.67. After two months, your balance would be up to $1,013.38 and you'd now earn interest on that new balance.
Over time, compound interest helps even small amounts of money grow a lot. Compound interest can turn that $1,000 into about $10,935 over 30 years, assuming an 8% return compounded monthly. Your initial deposit just keeps growing and earning more over time. And the sooner you start investing, the sooner your money starts working hard like this.
2. The longer you wait, the more you'll need to save to have enough
Because money grows so much over time, starting to invest early means you need to save a lot less to end up with a big retirement nest egg.
Say, for example, you start saving at 25, you want to save $1 million for retirement by age 65, and you earn an 8% annual return on your investment. You could hit that $1 million target by investing just $3,574 per year, or about $300 per month.
But if you didn't start saving until 45, you would need to save $20,234 a year, or about $1,687 per month, in order to become a millionaire at your target age. Saving $300 per month over the course of your entire career is a lot easier than saving almost $1,700 a month, especially when you probably have a lot of financial obligations already.
If you're already over 25, this lesson still applies: The longer you wait, the more you'll have to put aside each month in order to make up for lost time.
3. You can score tax breaks that you'll miss out on if you don't invest
Lots of tax breaks are available to help you save for retirement. If you have access to a workplace 401(k) plan, you can make pre-tax investments for your retirement. If you have no 401(k) at work, you can contribute to a traditional or Roth IRA, both of which are tax-advantaged accounts that help to defray the cost of retirement savings.
There are annual contribution limits for each of these retirement accounts. In 2019, for example, you can contribute a maximum of $19,000 to a 401(k) or $25,000 if you're 50 or over and eligible to make catch-up contributions.
Once each year has passed, your chance to make that year's tax-advantaged contribution is gone and you'll have forever given up the help the government was going to provide you that year in saving for your future.
And it's pretty nice help, too. Even if you can't max out a 401(k), a $5,000 deduction for a retirement account contribution would save you $1,100 in taxes if you were in the 22% tax bracket. Can you afford to give up $1,100 of government help in saving for retirement each year? If you can't, start making contributions to tax-advantaged retirement accounts right now.
Start saving for retirement today
As you can see, there are lots of reasons saving for retirement can't wait. So sign up for your 401(k) or open an IRA today and start putting away money. Even if you start small, you can put your money to work -- letting you stop working and enjoy retirement life.