What Are
the Advantages of Saving Sooner?
Most people have good
intentions about saving for retirement. But few know when to start or how much
is enough. Far too many people use credit cards as an additional income source
and sink further into debt. This leaves precious few dollars to put aside for
savings and retirement. And the interest on credit cards builds up much faster
than interest on a savings account.
Of all workers, more than
one-quarter have saved less than $10,000 for retirement.1
A better approach might be to allocate a certain amount for savings every month
and pay yourself as though it were an expense.
Let’s look at two
friends, Chris and Leslie, who are both 45 and saving for retirement 20 years
from now. Their financial advisor has told them that they need some savings in
addition to their employer-sponsored retirement plans. Both save $275 a month
for a 10-year period, and both earn 8 percent on their investments. But there is
a difference.
Chris starts saving today
and saves for 10 years. But Leslie waits 10 years before starting to save. Both
will have put away a total of $33,000. After 20 years, Leslie, the
procrastinator, will have accumulated $49,534, whereas Chris, the early starter,
will have accumulated $106,941. That’s more than twice as much available for
retirement with the same initial investment.
(This is a hypothetical example used for illustrative purposes
only and does not represent the performance of any specific investment. Rates of
return will vary over time, particularly for long-term investments. Taxes and
inflation were not considered. Actual results will vary.)
This example makes a
strong case. Not only does it pay to save, but if you start sooner, you can take
advantage of the power of compounding. For example, your deposits earn interest
and so does your reinvested interest. This is a good example of letting your
money work for you. The sooner you start saving for retirement, the more you
will have when you retire. And the sooner you start saving for retirement, the
sooner you will be able to retire.
If you have trouble saving
money on a regular basis, you may try savings strategies that force you to save.
Examples of forced savings strategies are whole life insurance,
employer-sponsored retirement plans, and direct payroll deductions. These
financial vehicles allow you to take your savings directly out of your paycheck
as an expense. This means you’ll be paying yourself even before your
creditors. Some of these options, such as whole life insurance and
employer-sponsored retirement plans, may also have deferred tax advantages that
further increase the advantage of saving early.
Distributions from a
tax-deferred retirement plan, such as a 401(k) plan, are taxed as ordinary
income and may be subject to an additional 10 percent federal tax penalty if
withdrawn prior to age 591/2.
Source:
1. 2002 Retirement Confidence Survey, Employee Benefit Research Institute
© 2003 Emerald Publications
