It’s tough being a younger worker in this economy. Whether you are facing an entry level salary in your first job out of college or are a thirty-something that has recently bought a home or started a family, you have many things competing for your paycheck. Some are fun, like going out with friends or taking vacation. Others are more mundane, like paying rent and buying gas. When that’s all done, you may ask “how am I supposed to save for my retirement”.
Things to remember
Saving for retirement is a marathon, not a sprint. Regular savings is the key to being able to retire. When you save money in a retirement account, and you leave it alone to grow, the money will multiply all on its own. It’s called compounding and is one of the most important concepts about saving. Here’s an example.
You are 25 years old and put $1,000 this year into your 401(k) at work. Assuming you make no further contributions, and the account grows at six percent per year, the value at 65 will be $10,285. That’s not enough to retire on by itself, but if you made that contribution each year you would accumulate $154,761. Not bad! (Note: Compound illustrations are not predictions of investment performance; investment principal and interest are not guaranteed and are subject to market fluctuation.)
Start by putting at least five to eight percent of your salary into a 401(k) plan at work if available, or an Individual Retirement Account (IRA) account or a Roth IRA account each year. As you get raises, the dollar amount will increase.
Consider increasing your percent contribution each year by one percent. Once you become accustomed to regular savings, you won’t even notice the increase.
Retirement savings = Sacred Cow. Avoid being tempted to withdraw money from your 401(k) when you change jobs. Don’t take loans from your retirement accounts. These things can sabotage your retirement.
Once I had a client who accumulated about $23,000 in his 401(k) account and then left the company. Luckily, he told me of his intention to take out the money from the 401(k) and use it to buy a new car. After we talked about it, he decided it was much better to leave it in a retirement account than spend it on a car.
First, taking money from a retirement account before you are 59 ½ years old is very expensive. He would have paid $5,750 in Federal income taxes, $1,092 in State income taxes PLUS a 10 percent premature withdrawal penalty from the IRS of $2,300. So he would net just $13,858, and that wouldn’t buy him the car he had in mind. But MORE IMPORTANTLY, taking the $23,000 now would deprive him of 38 years of compounding in the account. If untouched and left to compound at six percent, the $23,000 would have grown to almost $210,000 over time!
Don’t spend your retirement money now.
Social Security won’t save you. Social Security may still be around to help fund retirement, but it should not be counted upon as an exclusive source of income.
These days, it’s hard to separate truth from fiction. According to some, the system will hold up fine. Others see bankruptcy as imminent. The Social Security Administration projects that the current system is sound through 2036, but beginning in 2037 benefits could be reduced by 22 percent and could continue to be reduced annually. Only time will tell.
Some politicians are talking about means testing, which could result in a lower monthly benefit (or no benefit at all) depending on your other retirement assets. It’s much better to save a little more for the future — even if it means spending a little less now — so you can treat any Social Security payments as gravy for your retirement.
Plan for success. The solution is to be prepared. Save now, while you’re young, to potentially avoid problems when you’re older. Procrastination is the easiest thing in the world to do, but its effects can be devastating when it comes to your retirement planning. The only way to ensure that you will be in good shape for retirement is to save regularly NOW. Save what you can and increase your savings over time. If you’re not sure what to do or how to do it, contact a financial planner to help get you started.
FPA member Bruce W. Edwards, CFP®, AAMS™, is a Managing partner at Edwards & Owens Financial Strategies and Wealth Management in Ashburn, Va.