“Really wish I had saved less for retirement," said no one, ever.
Also never spoken: “That was quick and easy, building up my retirement nest egg!"
And for good reason.
Amassing enough wealth to coast comfortably through your sunset years is no simple feat.
So here's why both saving and careful planning are necessary: To sustain whatever lifestyle you've built for yourself by age 55 to 70, you'll likely need to be able to replace 70-90% of your pre-retirement income with savings and Social Security.
That's a lot of money, but building the retirement cushion you need to is a lot easier if you start at a young age. Here's a look at why, and how, you can start getting ahead today.
Time Is on Your Side—If You Start Early
A funny thing happens to invested money as time passes: compounding.
In simple terms, compounding is what happens when you earn money on re-invested investment earnings. It's a subtle but powerful phenomenon and the single biggest reason you should start saving as soon as you can.
Bear with us for a quick demo. If you invest $10,000 in a one-year certificate of deposit (CD, as it's more commonly known) that earns 2% annual interest, you'll walk away with $10,200 at the end of the year. If you re-invest that $10,200 in the same CD, you'll have $10,404 the following year. Repeat and walk away with $10,612. See how the amount you earn each cycle balloons, from $200 to $204 to $212, and you didn't even add any more money? That's compounding, and the effect accelerates over time. So the longer you allow it to work its magic, the more likely your retirement-self will be planning Mediterranean cruises.
In fact, saving in your 20s may be the most impactful move you can make to ensure your port-of-call sounds more like Bali than Baltimore. According to CNN Money, if you set aside $3,000 for 10 years every year from ages 25 to 35, never saving another dime, and earning a 7% annual return, you'll wind up with $338,000 at age 65. Start saving at 35, socking $3,000 away every year to age 65, and you'd finish with less—$303,000.
Now imagine what happens if you start early and add to the pot each year up through retirement. One way to do that is with regular transfers to a tax-advantaged retirement account—a 401(k), Individual Retirement Account (IRA), or, if you work for a school or nonprofit, 403(b).
Taxes Can Be on Your Side, Too
Ah, the tax code.
One bright spot of an otherwise confusing mess: Accounts like the ones mentioned above allow you to invest in ways that make taxes less...gruesome. For example, 401(k)s, which are offered by most big corporations, allow you to invest pre-tax dollars and defer paying taxes until you withdraw the money in retirement. The result: You can invest more upfront, which means you'll earn more money in the long run. The only caveat is you have to keep your hands off the money until at least age 59.5 or face a 10% penalty on withdrawals. (You'll want to talk to a tax professional for the specifics.)
More-generous employers will match your 401(k) contributions up to a certain amount, say 3%. To squeak as much money out of your job as humanly possible, it's worth saving at least the percentage of your income equal to the match. If you don't, you're throwing away free money.
Every employer's plan is different. It's worth taking the time to understand what options are available to you, and touring the IRS's description of retirement plans to gain a better understanding of common retirement terminology so you have some background going in.
“OK, But I Have No Idea What to Invest In..."
Investing is complicated, and a little intimidating. That said, if your employer offers a retirement plan, setting one up is probably pretty straightforward. Either way, don't be afraid to hold your employer accountable for advice. "As stewards of their employees' retirement plans," says Larry Fink, CEO of BlackRock, "companies must embrace the responsibility to build financial literacy in their workforce."
If you're still stuck, consider speaking with someone one on one. Make an appointment with a trusted financial advisor in your area and bring a list of questions. Also, be prepared to discuss your future financial goals besides retirement (like starting a business or saving for that dream home), so they can offer strategies to help you reach all of them.
Picture It
Here's another way to start thinking about retirement: What kind of life do you want? Do you want to have to forego all travel and eat all of your meals at home in your 70s, with an anxious eye on your dwindling savings, or do you want to be strolling on a tropical beach with lobster on the brain? If you think about what kind of life you want, and work backwards to see how much that's going to cost you in savings today, you may be more motivated to start early.
You'll thank your younger self when you're fastening your lobster bib on that Mediterranean cruise.