You've probably read that you'll need a million dollars to retire - maybe more. Does that figure seem so daunting that you haven't even started saving for retirement or you feel like you aren't saving nearly enough? Don't be discouraged - we'll show you why small retirement savings count. (Keep saving when mortgages, marriages and debt demand your attention. See Retirement Savings Tips For 25- To 34-Year-Olds.)

TUTORIAL: Budgeting Basics

1. Compound Interest Makes Your Money Work for You
No matter how little money you have invested, if you leave the account alone and let it earn interest, you'll end up with more money than you started with. Let's say you have $500 and it earns 5% interest a year. In year one, you have $500. In year two, you will have $500 + $25 interest, for a total of $525. In year three, you have $525 + $26.25 interest = $551.25. With no additional effort on your part besides depositing the money and investing it in something that earns interest, your money will grow. Anything extra you can contribute to the account, even if it's only $10 a month, will help your balance grow even faster.

2. Old Habits Die Hard
If you're in the habit of putting some of your money toward your retirement savings, you've developed a good habit. With the right savings mentality and behavior already in place, you'll be perfectly positioned to increase your savings rate in the future if your circumstances allow for it. Just having a retirement account set up, understanding how it works and knowing how to invest and what to invest in can benefit you even if you have little or nothing to save right now. When you do have the money to contribute, there will be nothing standing in the way of putting your money to work.

3. Saving for Retirement Can Lower Your Tax Bill
Saving for retirement might be more within your reach than you realize. That's because certain types of retirement accounts allow you to contribute pre-tax dollars. This means that you don't have to earn as much money now to contribute more to your retirement today. You'll pay the tax bill many years down the road when you withdraw the money.

Let's say you want to put $100 a month toward retirement savings, but after all is said and done, you only have $75 a month leftover. Let's also say that your marginal tax rate is 25%, meaning that on the last $100 you earn, the government takes $25. If you didn't have to pay tax on that last $100, you'd have $100, not $75. You can put that $100 toward your retirement if you invest it in a 401(k) through your employer or a traditional IRA on your own. If you'd rather pay the taxes now, however, you can put the $75 in a Roth IRA.

4. Your Employer Might Help You Save
Many employers will contribute to their employees' 401(k) accounts, but only if the employee chips in first. A common plan is for an employer to match an employee's contribution up to a maximum of 5% of the employee's salary. Suppose you make $50,000 and your employer offers this matching incentive. Here's how much free money you could get from your employer by contributing to your 401(k):

You Contribute Your Employer Contributes Total Annual Contribution
0.0%, $0 a year 0 $0 + $0 = $0
0.5%, $250 a year $250 $250 + $250 = $500
1.0%, $500 a year $500 $500 + $500 = $1,000
2.0%, $1,000 a year $1,000 $1,000 + $1,000 = $2,000
3.0%, $1,500 a year $1,500 $1,500 + $1,500 = $3,000
4.0%, $2,000 a year $2,000 $2,000 + $2,000 = $4,000
5.0%, $2,500 a year $2,500 $2,500 + $2,500 = $5,000
6.0%, $3,000 a year $2,500 $3,000 + $2,500 = $5,500

When you break these annual contributions down into 26 biweekly pay periods, you'll see that you can start getting free money from your employer just by putting $9.62 per paycheck into your 401(k). You don't even have to pay taxes on that $9.62 (for now!).

5. Small Savings Really Do Add Up
If your employer doesn't offer a matching contribution, you can still take an important lesson from the previous tip: it only takes a little bit of money, set aside on a regular basis, to make a significant difference in your savings. Saving that $9.62 per paycheck gives you $250 at the end of the year. At the higher end, $192.31 per paycheck would give you $5,000 by the end of the year, which is the maximum you can put in a traditional or Roth IRA for 2011. If you have the money automatically withdrawn from your checking account and placed into your retirement account, you'll probably get used to meeting your monthly expenses without it and saving for retirement will seem easy. (Be sure to consider the tax benefits and the eligibility requirements of the Roth IRA. Check out An Introduction To Roth IRAs.)

The Bottom Line
Maybe you can't afford to put much of your income toward retirement savings right now, but don't let that hold you back. Even if you can only save 0.5%, you'll still be making progress toward your goal.

Related Articles
  1. Retirement

    Going Back to Ecuador to Retire: A How-to Guide

    Spending your retirement years in Ecuador can be an affordable and attractive proposition, provided you know the country's laws.
  2. Retirement

    Is the New myRA Plan Right for You?

    The new myRA accounts seem to deliver on their promise of being “simple, safe and affordable.” Just be prepared for paltry annual returns.
  3. Credit & Loans

    Should I Use My IRA to Pay Off My Credit Cards?

    Cashing in an IRA to deal with outstanding credit card balances may not be the best way, but sometimes it's the best available way. Here's how.
  4. Investing Basics

    Fee-Only Financial Advisors: What You Need To Know

    Are you considering hiring a fee-only financial advisor or one who is compensated via commissions? Read this first.
  5. Financial Advisors

    Paying for College: Top Ways to Budget and Save

    Saving for your kids' college education can be complex and expensive. Here are some popular vehicles that help perpetuate college funds.
  6. Retirement

    How Much Money Do You Need to Retire at 56?

    Who wouldn't want to retire early and enjoy the good life? The question is, "How much will it cost?" Here's a quick and dirty way to get an answer.
  7. Retirement

    The Best Strategies to Maximize Your Roth IRA

    If a Roth IRA makes sense for you, here are ways to build the biggest nest egg possible with it.
  8. Retirement

    Suddenly Pushed into Retirement, How to Handle the Transition

    Adjusting to retirement can be challenging, but when it happens unexpectedly it can be downright difficult. Thankfully there are ways to successfully transition.
  9. Investing

    What a Family Tradition Taught Me About Investing

    We share some lessons from friends and family on saving money and planning for retirement.
  10. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  1. What are the main differences between a systematic investment plan (SIP) and mutual ...

    Mutual funds are often described as a basket of stocks or bonds, depending on the fund's investment objectives, managed by ... Read Full Answer >>
  2. Can a 401(k) be taken in bankruptcy?

    The two most common types of bankruptcy available to consumers are Chapter 7 and Chapter 13. Whether you file a Chapter 7 ... Read Full Answer >>
  3. When can catch-up contributions start?

    Most qualified retirement plans such as 401(k), 403(b) and SIMPLE 401(k) plans, as well as individual retirement accounts ... Read Full Answer >>
  4. Who can make catch-up contributions?

    Most common retirement plans such as 401(k) and 403(b) plans, as well as individual retirement accounts (IRAs) allow you ... Read Full Answer >>
  5. Can you have both a 401(k) and an IRA?

    Investors can have both a 401(k) and an individual retirement account (IRA) at the same time, and it is quite common to have ... Read Full Answer >>
  6. Are 401(k) contributions tax deductible?

    All contributions to qualified retirement plans such as 401(k)s reduce taxable income, which lowers the total taxes owed. ... Read Full Answer >>

You May Also Like

Trading Center