Saving for retirement isn’t high on the priority list for some Millennials. After all, there are lots of other financial obligations you probably have to worry about right now — things like repaying college loans, buying a car and paying for car insurance, and saving for a down payment on a first home.
But if you’re in your 20s or 30s, failing to start planning for retirement now is one of the biggest financial mistakes you could make in your entire life. “You’re only young once,” the old saying goes, and this is especially relevant when it comes to saving for retirement. This is because you can never recapture the returns from the years of saving that were lost during this time.
Compounding and the Rule of 72
The power of compounding makes time the greatest ally of retirement savers. A mathematical formula called the “Rule of 72” illustrates the financial power of compounding. According to this rule, your money will approximately double in the number of years equal to 72 divided by your return.
So let’s assume that you earn an average annual return on your retirement savings of 6 percent. In this case, your savings would double in approximately 12 years. Put another way, every decade that you wait to start saving for retirement might be a lost decade when you could have, but didn’t, double your money.
Jumpstart Your Retirement Savings
Here are four steps to help you take advantage of compounding and the Rule of 72 to jumpstart your retirement savings:
- Make it a priority. This is critical because, as noted above, there may be other seemingly more urgent financial priorities screaming for your attention. The best way to make saving for retirement a priority is to create a budget.
Your budget should start with your living essentials, which are things like rent, utilities, transportation and food. Next should come debt repayment; for example, student loans or a car payment. And then should come retirement savings — yes, even before entertainment.
In our opinion, try to save 10 percent of your gross income for retirement. But if you can’t save this much, save whatever you can and set a goal of increasing your savings contribution each year or whenever your income increases, like when you get a raise at work.
- Make it automatic. The best way, from our experience, to make saving for retirement automatic, is by enrolling in a retirement savings program (like a 401(k) plan) at work. When you do, your contributions will be automatically deducted from your net pay and transferred into your retirement account.
If you don’t have access to a retirement plan at work, consider opening an Individual Retirement Account (IRA) yourself. Then arrange for a set amount of money to be automatically transferred from your bank account into your IRA each month on the same day. This is sometimes referred to as “paying yourself first” — if you never even see the money, you’re less likely to spend it on other things.
- Choose the right retirement savings vehicle. You may have several different retirement savings vehicles to choose from, including a 401(k) plan at work and an IRA on your own. With a 401(k), your salary is reduced by the amount of your contributions, which could also lower your current taxes.
There are two main types of IRAs: traditional IRAs and Roth IRAs. Traditional IRAs are similar to 401(k)s in that contributions may be tax-deductible, thus lowering your current taxes. You will pay taxes on the money when you start making withdrawals in retirement. Roth IRAs don’t offer a current tax break, but your savings grow tax-free and withdrawals made in retirement are tax-free as well.
- Leave your retirement savings alone. We at Frontier, among others, know that this is one of the biggest retirement planning mistakes many young people make: Tapping into their retirement account before they retire. Doing so can be very costly for at least two reasons.
First, you may pay a 10 percent penalty and taxes on early withdrawals, depending on the type of retirement plan. And second, funds that you withdraw from your account now for non-retirement purposes won’t be there for you when you retire. This is true not only of the money you withdraw, but also the earnings that might have accrued on these funds had you left them alone.
We can help you implement these and other steps to jumpstart your retirement savings. Please contact us if you’d like to discuss this in more detail.