Retirement?! That’s so decades away! But over and over, you hear it said, “Start planning today!”
Here’s a two-step approach to help you learn how to develop a savings plan and accumulate a substantial retirement fund.
Step 1. Make saving a habit.
We all have habits – good and bad. For your savings fund to be meaningful in the long run, you need to make saving a habit now. If you’re starting a career, setting aside just $10 a week can be a great starting point. $10 is just one trip out for lunch or 1 ½ stops to the local barista.
Consider this plan:
- Start setting aside $10 each week into a tax-deferred Individual Retirement Account. With an Individual Retirement Account, you may be able to deduct your annual contributions from current taxes, depending on your income.
- Each year, add $1 to your weekly savings amount. This can be added from increased earnings.
- Stick with this plan or increase your savings contributions throughout your career.
- As you accumulate funds, invest them in a diversified portfolio that will yield a good return.
Let’s assume you place your funds in savings and investments that yield an average of 5% per year after taxes. (That’s a pretty conservative assumption.) After ten years, you will have accumulated approximately $8,705. After twenty, you will have $29,248.
Keep to the plan for 40 years, and your balance will have increased to $141,569.
How much came out of your pocket? $56,640. The extra $84,929 comes from the magic of compounding interest. This step alone provides a nice amount to help sustain you in retirement. But it probably won’t be enough on its own. That’s why you need to take the second step as soon as you are able.
Step 2. Get in that 401(k) plan!
A 401(k) is a benefit that deducts a portion of your earnings before taxes and places them in an investment plan where they grow tax-free until your retirement. In many cases, your employer will match all or a portion of the amount you contribute each year. So, not participating is like saying no thank you to FREE money.
Here is one approach that makes it easy to get started in a 401(k) and take full advantage of your retirement fund growth potential.
- Begin by contributing 3% of your earnings. For most people, this is an amount that doesn’t uncomfortably harm their budget. Taxes would have been withheld on the full 3% if you didn’t contribute them to the 401(k). Since taxes are not withheld on your 401(k) contribution, the net reduction in your take-home pay is less than the 3% that you’re investing.
- In the second year, increase your contribution to 4%. Do this at the same time you receive an increase in pay so that it doesn’t reduce your net take-home pay.
- Continue adding 1% to your contribution each year as long as you can. An eventual contribution amount of 8% to 10% of annual salary is a good goal.
What impact can a plan like this have on the funds you have available when you’re ready to retire?
It can be huge!
Suppose you start with a $25,000 annual salary and invest 3% of your earnings in your 401(k) and add a 1% increment each year until you contribute 10% every year. Let’s also assume that you place your funds in diversified investments that yield you 5% per year. (That’s another conservative assumption.) Finally, we’ll project that your earnings grow 3% each year.
Even if your employer does not offer a match, your funds will grow to levels that may surprise you. After ten years, you will have accumulated over $26,000. After twenty, you will have over $93,000 in your retirement fund.
When you’re ready to retire in about 40 years, your 401(k) funds will have grown to $448,000.
Now, let’s assume your employer matches up to 5% of your contribution each year. Your funds will have increased to over $691,000 after 40 years.
With plans 1 and 2, you will have accumulated over $750,000 when you’re ready to retire.
According to the Federal Reserve, in 2013 the typical American aged 55 to 64 years old has $103,000 in retirement savings. Is that enough? You will want to do better than that.
What’s the key?
Start early. When it comes to saving and investment, time is on your side. The longer you save, the more your funds grow.
This plan may not be perfect for you. You may be able to save more, or you may need to save less. The important thing is to save something and get started as early as possible.
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