Everyone dreams of being a millionaire, and if you're on track for your retirement savings goals, there's a good chance you'll get there. Unfortunately, most people are not.
Here's an overview of how behind Americans are at preparing for a comforable retirement: 21% of Americans have no retirement savings at all, according to a study by Northwestern Mutual. Millennials are particularly guilty of neglecting retirement savings, with two-thirds having nothing saved, according to the National Institute on Retirement Security. It's easy to fall into the trap of thinking there's plenty of time to make up your savings, but the reality is that your early retirement contributions matter a whole lot more than your later ones. Why? Read on.
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Compound interest and your retirement savings
When you put money in your retirement account, it will grow over time, assuming you've made smart investments. At first, you'll just earn interest on the principal amount you contributed, but as time goes on, you'll start earning interest on your interest. This is what is known as compound interest, and it can make a big difference over time.
To illustrate this point, consider a $5,000 annual investment begun at different points in a person's life. Let's assume that all of these investments earn an 8% annual return and that this person plans to retire at 65. Here's how much they would have if they contributed $5,000 per year starting at 25, 35, 45 and 55, rounded to the nearest thousand:
As you can see, the earlier you begin contributing, the more time compound interest has to grow your contributions. This means you can put in less of your own money and end up with a bigger nest egg in the end. If you wait to begin making retirement contributions, you're making your job much harder.
How much money do I need for retirement?
You may have heard that $1 million is the magic number for retirement savings, but it's not that simple. Everyone will need a different amount for retirement, depending on how long they live, what kind of lifestyle they hope to have and how much they will receive from Social Security. You may be able to get by on less than $1 million if you live frugally, but you may need much more than this if you live in a city or you plan to travel a lot in retirement.
If you haven't done so already, you should estimate living expenses in retirement and the length of your retirement. Average life expectancy in the U.S. is 78.6 years, but you may live longer or shorter than this. Subtract your estimated life expectancy from your preferred retirement age to figure out how many years of retirement savings you need. Once you have this information, you can plug it into a retirement calculator that will do the calculations for you, including factoring in inflation. Then, subtract what you expect to get from Social Security to figure out how much you need to save on your own.
As I mentioned above, $1 million is a somewhat arbitrary number, but you can use it as a starting point to figure out how much you should be saving per month. The table below shows how much you would need to contribute to your retirement accounts each month in order to retire at 65 with $1 million, assuming an 8% annual rate of return on your investments. If you determine you need more than $1 million for retirement, you should make an effort to contribute more than this.
If you wait until you're in your 40s or 50s to start saving, you'll have a much tougher road ahead. It's worth noting that the 55-year-old saver wouldn't be able to reach their goals with 401(k)s and IRAs alone. They would have to save nearly $65,600 per year, and 401(k)s only allow a maximum contribution of $25,000 for adults 50 and up in 2019. IRAs only allow a maximum contribution of $7,000. So even if you could afford to save $65,600 per year, you would have to keep some of it in a savings account or put it in a non-tax-advantaged investment account.
How do I get started?
If your employer offers a 401(k), this is the best place to start saving for retirement, especially if your company matches your contributions. If your employer doesn't offer a 401(k), you can open an IRA on your own instead. However, you won't earn any matching contributions. You're allowed to contribute up to $19,000 to a 401(k) and $6,000 to an IRA in 2019.
Adults 50 and older are also allowed to make catch-up contributions of $6,000 to a 401(k) and $1,000 to an IRA, as mentioned above. If you put off retirement savings when you were younger and you're now worried about whether you'll have enough, it's a good idea to take advantage of catch-up contributions if you can afford to do so. You'll have to work a little harder, but it is still possible to reach your savings goal.
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