Click here to watch our latest video, Best Financial Advice from Jennifer: Early Retirement Savings and Compound Interest. A full transcript of the video featuring Jennifer Pieson, FPQP™ is below in italics:
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Jennifer Pieson, FPQP™, Financial Planning Analyst
(Transcript)
Hi, and welcome! My name is Jen Pieson, and I’m a Financial Planning Analyst with Agili. Today I want to talk about one of the best financial choices you can make as a young adult: starting to save for retirement at an early age.
Why Save Early for Retirement?
Right now, fewer than half of Americans between the ages of 21 to 32 have started saving for retirement. Retirement may feel like a long way off, but today’s workers don’t have the same financial safety nets that our grandparents had. Pensions used to be common, but they’re increasingly rare for people entering the workforce now. In addition, the Social Security Administration estimates that, in 2035, it will begin paying reduced benefits…at 79 cents on the dollar. Young adults can’t count on these resources the way previous generations could, and now the onus is really on the employee themself to save for their own retirement.
Early Retirement Savings: Long Timeline
There are two benefits to beginning to save early, and they’re really intertwined. One is your long timeline, and the other is compounding interest. Regarding your long timeline, let’s say you plan to retire at age 65. If you start saving at age 23, you have 42 years to save. If you wait until you’re in your 40s, you’re down to half the time. You might think, “Well, I’ll just wait until I’m in my forties and then save twice as much,” but that’s where compound interest comes in.
Early Retirement Savings: Compound Interest
Compound interest happens when you make a deposit, and you earn interest on that, but then you earn interest on your interest, which creates a snowball effect. Because of compounding interest, your eventual nest egg has less to do with the amount you’re saving and more to do with the amount of time your money is invested.
For example, let’s say you want to retire with one million dollars at age 65. If you started saving at age 20, you would need to put away about $4,500 a year. If you wait until you’re 30 before you begin saving, you need to up that amount to about $9,000 a year. At age 40, you would need to save $18,000 per year. In each of these scenarios, the longer you wait, the more money you will need to save, and the less interest you’ll receive because you’ll have less time to receive it.
Early Retirement Savings Means Smaller Total Contribution
Another thing to note is that the earlier you start saving, the less your total contribution needs to be. If you started putting that $4,500 away at age 20, your total contribution would be $202,500, and the rest of that million ($797,500) is made up entirely of interest. The longer you wait, the more your contribution needs to be because there’s not as much time to earn interest. If you start saving $18,000 per year when you’re 40, your total contribution would be $450,000 (more than twice what the 20-year-old contributed!) and the interest would be $550,000 to get to that $1 million at age 65.
Start Saving Now!
So: start saving now! Even if it’s just a little bit. If you’re eligible to contribute to a 401(k) or 403(b), definitely do that. Everyone says to contribute at least as much as your employer will match but aim for higher than that. You should be saving between 10 and 15% of your income toward retirement. If you can’t afford to save that much yet, start slow and ramp up as you can. If you can’t contribute to an employer retirement plan at this time, open an IRA and start to save that way. If you wish you’d started a few years ago, don’t put it off any longer. As you may have heard before, “The best time to plant a tree was twenty years ago. The second-best time is now.”
If you’d like to learn more about compounding interest, visit our blog at agilipersonalcfo.com. We also have a series of blog posts, Kids’ Personal Finance Game and a PDF of the game, on our website because we believe that financial education should be a lifelong journey. If you have any questions, please feel free to contact Agili. Thanks, and take care!