Retirement is a beautiful thing, by most accounts. After decades of work, it's a time to embrace selfishness and do whatever fulfills you. Or at least that's the plan, ideally. To help make sure you can live a fulfilling retirement, it's important that you financially plan for it well ahead of time.
Although many people dread the idea of planning -- especially for something that may be years or decades away -- it can be relatively straightforward. There are a lot of working parts to retirement, but cutting through the noise can help you focus on what's essential in the grand scheme of things.
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One table can put retirement planning into perspective
| Years | Personally Invested | Total Investment Value |
|---|---|---|
| 10 | $120,000 | $191,200 |
| 15 | $180,000 | $381,200 |
| 20 | $240,000 | $687,300 |
| 25 | $300,000 | $1.18 million |
| 30 | $360,000 | $1.97 million |
Data source: Calculations by author. Numbers rounded to the nearest hundred.
The above table is arguably the most important retirement table you'll ever see. It shows how $1,000 monthly investments would grow over the years if you averaged 10% annual returns during that span.
The numbers themselves aren't significant because they'll fluctuate based on your personal situation, but the larger point it shows is what's important: Time is one of the greatest assets in investing.
The power of compound interest
Compound interest can be a double-edged sword in finance. When it comes to debt, compound interest can quickly make a bad situation worse. When it comes to investing, compound interest (or compound earnings) is one of the surest ways to build wealth. It occurs when the interest you earn on investments earns interest on itself.
To see compound interest in action, let's return to our above example, where you invest $12,000 annually and average 10% returns. In the first year, you'll earn $1,200 on your investments. Assuming you reinvest profits, you'll earn 10% on $13,200 in year two ($1,320). In year three, you'll earn 10% on $14,520 ($1,452). Rinse and repeat.
Making money on your investments is good; making money on the money you made is even better.
For compound interest to work its wonders, it needs time. Notice in our table that the more time invested, the wider the gap between what's personally invested and the ending investment value. After 10 years, the difference (capital gains) is just over $71,000. After 20 years, it's over $447,000; after 30 years, it jumps to over $1.6 million.
Not bad for essentially no extra work needed outside of reinvesting profits and letting time be your crutch.
A Roth IRA can easily save you thousands
The great news is that compound interest can greatly increase your capital gains. The bad news is that capital gains are taxable. Depending on your income, you'll either owe 0%, 15%, or 20% on capital gains when you eventually sell your stocks.
That's where an account like a Roth IRA (individual retirement account) can come in handy. In a Roth IRA you contribute after-tax money, with tax-free withdrawals in retirement if conditions -- like being 59 1/2 years old and owning the account for at least five years -- are met.
Roth IRAs have contribution limits way below $12,000 annually ($6,500 and $7,500 if you're 50 or older in 2023), so using that to showcase savings wouldn't be accurate. But here's how much could be saved in general depending on how much you had in capital gains.
| Capital Gains | Amount Owed at 15% | Amount Owed at 20% |
|---|---|---|
| $100,000 | $15,000 | $20,000 |
| $150,000 | $22,500 | $30,000 |
| $250,000 | $37,500 | $50,000 |
| $500,000 | $75,000 | $100,000 |
| $750,000 | $112,500 | $150,000 |
Data source: Calculations by author.
The income cap to be eligible to contribute to a Roth IRA is $153,000 if you're single and $228,000 if you're married and filing jointly.
The money you can save with a Roth IRA will go a lot further in your pockets in retirement than it will in Uncle Sam's.
