In your twenties it is a good idea to start saving sooner rather than later because it will make all the difference in your sixty and seventy-somethings.
Why save for retirement? During our working years, we cover our expenses with the money we earn. Our rent or mortgage, cell phone bills, insurance, gasoline etc., are covered by our paychecks. Fast forward a few years to the time that you are ready to retire and enjoy life and ask yourself: How are you going to cover your expenses if you no longer have that paycheck? With the population’s life expectancy growing, how will you maintain your lifestyle for 20 or 30 years?
Social Security is one source of retirement income; however, the benefits for people younger than 40 years of age are likely to be reduced in the future.
The Economic Policy Institute found that Americans age 56 to 61 had a median balance of $21,000 in their 401(k) accounts in 2016 which reflects almost 30 years of savings. It’s clearly not wise to just count on Social Security so you need to build enough wealth between now and your retirement to sustain your lifestyle for 20 or 30 plus years.
Why save as soon as possible? Now that you understand why you need to save for retirement, when should you save? Most people put off saving for retirement until they think they can afford to save, but this is a huge mistake. Time and compound growth have a powerful effect that is hard to makeup as seen in the following example.
Lauren and Cameron are twins, working at the same company, earning the same income. They both want to have $1,000,000 saved for retirement at age 65. At age 25, Lauren began saving about $5,000 each year (specifically $417 per month, or $5,004 per year). Over the years, Lauren only invests a total of $200,360 into her retirement plan but
with a 7% annual rate of return, she will have $1,000,000 at age 65. Cameron waited until she was age 45 to begin saving for retirement, so assuming she earned the same 7% annual rate of return, she had to save about $24,000 each year (specifically $2,032.75 per month, or $24,393 per year). For Cameron to reach the same $1,000,000 at age 65 savings goal, she needed to save a total of $487,860; more than twice as much as Lauren saved.
Is Cameron really able to better afford saving later? Cameron didn’t think she could afford to save $5,000 of her $45,000 income when she was 25 as it represented 11% of her income at that time. However, to reach her $1,000,000 savings goal at age 45 she now needs to set aside $24,000 per year. While she’s making $80,000 at age 45, she can’t better afford to save as this level of saving now means doing without 30.5% of her income at a time where family demands and associated costs are much higher. At age 45 Lauren is also making $80,000 but to stay on track she only needs to continue to save $5,000 annually which represents only 6.25% of her income, leaving room in her budget for costs to care for her children and family.
Another way to put this is if you save $5,000 every year beginning at age 25, with a 7% return, at age 65 you will have $1,000,000, but if you wait to 45 to save the same $5,000, you will only have $204,977! The following chart summarizes the numbers.
|Goal of Saving $1,000,000 at Age 65 (Assuming 7% Annual Return)|
|Savings Annually and Percentage of Income at Age 25||$5,000/year
11% of income
|Savings Annually and Percentage of Income at Age 45||$5,000/year
6.25% of income
30.5% of income
You might want to rethink your savings plan if you think it will be easier to save when you are making more money. It’s actually easier to live on less when you are young because many of your friends are also struggling and you have less financial responsibilities from family life. If you wait to save until you are earning more in your 40s, you will have to save substantially more at a time when you have become accustomed to your lifestyle, might have children and have other needs, wants and goals. As the timeline on the first page outlines, your discretionary income in your 40s is typically less than in your 20s and 30s.
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 Wall Street Journal, Kelly Greene and Vipal Monga; 2013 March 19; http://online.wsj.com/article/
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