“Wish I had started saving for retirement later,” said no one – ever! So, when should you start saving for retirement? As early as possible – in your 20’s if you can. Most people rely on social security and savings as their sole source of income after retirement, and it can take a long time to build up enough savings to live comfortably.
The good news is, if you start saving while you are young, then chances are you can achieve this goal. One reason why you should start early is to take advantage of the compounding of interest or investment income on your money. How does that work? Here is an example.
If you put $5,000 in a certificate of deposit at the bank that earns 2% per year, then at the end of the first year you will have $5,100. If you then invest that $5,100 for another year at the same interest rate, then you will have $5,202 at the end of that year. Keep going and at the end of the third year you will have $5,306. The effect of compounding is that while you started with $5,000, each year you made increasingly more interest: $100, $102 and $106. And that is without adding any more to your initial savings!
According to the Edward Jones savings calculator, if you save $3,000 per year starting at age 25 and you can get 7% interest per year on your money, then at the end of 40 years you will have about $600,000. You can calculate your own projected savings using one of several online tools such as Edward Jones, CNN and MSN. But you should plan to increase your annual contribution to your savings each year, assuming your annual salary increases as well, so that you can maximize your total retirement savings.
How much is enough?
But how much will you need at retirement? Assuming you have accumulated $1 million by the time you are in your 60’s, and you want it to last for 30 years, then you should plan to take out no more than 3% per year ($2,500/mo.), with just enough of an increase each year after that to match inflation to maintain the same spending power, according to a 2015 CNN Money article.
Where to invest your savings? Most employers offer a 401(k) retirement savings plan. Putting savings into a 401(k) plan is a great option because it allows you to save money with pre-tax dollars and defer paying income taxes on your savings until you pull the savings out at retirement, at which time you will likely be in a lower income tax bracket and will save even more. Also, many employers will match your contributions to your 401(k) plan up to a certain cap, which gives you even more savings to invest.
If $2,500 per month in retirement doesn’t sound like much, you are not alone. Most people do not realize how much savings it takes to live comfortably in retirement and therefore, don’t plan well. That is why it is so important to save as much as you can and start as early as you can!