Whether you’re a student, postgraduate, or entry-level employee, it’s never too early to start saving for retirement. Even if retirement is thirty years down the road, saving now could help alleviate stress and anxiety in the long-run. Here’s why you should start saving now for retirement and how to do it.
How Do Retirement Plans Work?
Before we get down to the perks of investing in retirement early, it’s important to understand what a retirement plan is and what options are available. A retirement plan typically incorporates an account you can invest money in annually that will grow over time with compound interest.
Some retirement accounts are referred to as pension plans. This is a fund where an amount of money is added over your working years and oftentimes only accessible once you reach a certain age or threshold. Many government organizations and large companies typically offer this to employees.
The most commonly used retirement accounts are Individual Retirement Accounts typically referred to as IRAs and a 401(k). The best part is that you can invest in both depending on your circumstances!
What is an IRA?
An IRA is a type of retirement account that allows you to input pre-taxed income into bonds, stocks, cash, ETFs, and even mutual funds. These investments grow without tax until you withdraw them when you retire. The account can be opened with any financial institution that’s been approved to do so by the IRS. You’ll typically need to wait until a certain age to actually use funds from this account or you could be charged an early-penalty withdrawal fee. You might also be subject to income tax if you withdraw early.
There are a few types of IRAs available including a SEP, ROTH or SIMPLE in addition to the traditional IRA. SEP and SIMPLE IRA accounts are usually used by business owners or someone who is self-employed. A Roth IRA incorporates after-tax contributions and oftentimes will allow tax-free withdrawal in retirement. There is typically a cap on how much you can put into a retirement account yearly.
Ultimately, one of the main perks of investing in an IRA is tax-deferred or tax-free growth. It’s also a way to supplement any savings or even Social Security.
What is a 401(k)?
Like an IRA a 401(k) is another retirement account that allows you to save. These accounts, however, are offered through your employer and allow you to make automatic contributions typically through automatic payroll systems. Like an IRA, your contributions won’t be taxed until you withdraw in retirement, although a Roth 401(k) allows tax-free withdrawal by investing taxed income. Many companies even offer to match your contributions to your 401(k), which essentially gives you free money.
Why Should I Start Saving Now?
Now that you understand your options, here are several reasons why you should start investing now, even if it’s difficult to think about the future.
The Compounding Effect and Compound Interest:
The compounding effect is the idea that if you reinvest your money, you can earn even more money in the long-run. Every year, your investment collects annual interest which can range depending on the account. This is added on top of the initial amount you put in and builds up year after year.
For example, if you invest $10,000 into a retirement account at age 20 with an annual interest rate of 7%, by the time you’re 60, that investment could equal nearly $150,000. If you invest that for a twenty-year period with the same interest rate, you may only get about $39,000 for retirement. So the earlier you start, the more money you can save in the long-run.
Don’t Miss Out on Free Money
If you work for a company that offers to match the amount you put into your 401(k), every year you postpone investing in a 401(k) is money lost. Additionally, the IRS caps the amount you can put into retirement accounts every year. For example, in 2019 and 2020 individuals can put up to $6,000 annually into retirement accounts while those older than 50 can add an additional $1,000. Even if you try to make up for lost time, you lose those past opportunities to invest, you lose the extended compound interest, and you’ll decrease the end value you get in retirement.
Social Security isn’t Enough
Social Security is typically taken out of every U.S. worker’s paycheck. It offers benefits to retirees as well as those with disabilities. Typically, you can’t start receiving Social Security until you’re 62, and while receiving the money is definitely a relief, it’s not enough. According to the Social Security Administration, benefits cover only about 40% of your pre-retirement income. Therefore, if you want to live a comfortable life after retirement, you’ll need an account to supplement it.
It’s often hard to start planning ahead for the end of your career, especially when you’ve just started your first job. But taking the time to prepare now for the future will help you live a more comfortable life in the long-run.