Why Small Retirement Savings Count
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.
A phrase commonly used in personal finance and retirement planning ...
An estimation of revenue and expenses over a specified future ...
Personal finance: all financial decisions and activities of an ...
A deposit account held at a bank or other financial institution ...
An investing tool used by individuals to earn and earmark funds ...
An extra allocation of funds to a retirement savings account ...