Saving for Retirement at Different Life Stages

At any age, saving for retirement should be an important component of your overall financial strategy. However, as you move through life and develop in your career, the ways in which you prepare will be different. When you’re just starting out in the workforce, you’re likely just trying to be financially independent from your parents. As you move through your career, your earnings increase, but often so will the number of conflicting financial priorities. After the kids have grown up, you probably have much more discretionary income, but unfortunately, a much shorter time horizon to retirement.  How can you ensure your retirement plan stays the course in the midst of other conflicting obligations? This three part series takes a look at how to plan for retirement at different life stages.

Developing professional

Understandably, it can be difficult for many to put emphasis on saving for their eventual retirement when they may have only a couple of years of work experience under their belt. Although it may be decades away, it is recommended to start putting money away for the later years as soon as possible. The power of compounding over the long time horizon until retirement will allow your retirement contributions to work harder for you than if you delayed saving for even five or 10 years.

What is compounding? In most retirement accounts, your pre-tax contributions and employer contributions will grow tax-deferred. Those contributions are increased by any interest, dividends or capital gains that the investments receive, which are reinvested, allowing your money to grow much faster.

JP Morgan provides an example of how an individual who saves $5,000 annually between the ages of 25-35 will typically end up with over $1.1 million dollars by the time they’re 65, versus another person, who invests the same amount annually between the ages of 35 and 65, but will end up with a much smaller amount, a little over $560,000. Both examples assume a 7% annual return, but in the first scenario, the early bird saver contributed $100,000 less than the late starter, and still achieved nearly twice the return due to the power of compounding. Also, younger investors can typically take a more aggressive approach to their asset allocation, as they have time on their side. While your allocation will depend on your goals, age, risk tolerance, and so on, starting out with a more aggressive approach can often add to the benefits of compounding in the long term.

Many companies offer an employer-sponsored retirement plan, such as a 401(k), 403(b), or a type of IRA. In most plans, employees are able to contribute a percentage of their salary, up to IRS guidelines. As an added benefit, some companies match the employee’s contributions, up to a certain percentage or dollar amount. Especially when starting out, making the most of an employer match is essential to getting started on the right foot. It is free money – so don’t leave any on the table! Of course, it is important to understand that all investments do hold a risk, as the funds will have gains and losses, depending on the financial market and the performance of the investments.

Throughout life, keep in mind the concept of paying yourself first. By having your retirement contributions automatically withdrawn from your paycheck, you’ve already paid yourself, and can work within your net pay to budget each month. If financially feasible, it is advised to accelerate the contributions to your retirement plan by 1% annually, with the goal of contributing 10% by your mid-to-late twenties. In 2015, those under 50 have a contribution limit of $5,500 for their IRA account and $18,000 to their 401(k).

When you’re just starting out, money can be tight, and it can be hard to imagine saving for a goal decades away when you have student loans and rent due tomorrow. As you work through your budget and determine what you can reasonably contribute, set benchmarks for yourself. Plan to contribute at least up to the matching amount from your employer, or perhaps five percent of your compensation. Even if you cannot increase your contribution amount annually, you’re still realizing the benefits of compounding. In the second part of the series, we’ll discuss saving for retirement as your income grows…and perhaps also your family.

The material contained in this article is for general information only and should not be construed as the rendering of personalized investment, legal, accounting, or tax advice.

To learn more about Thomas McFarland, view his Paladin Registry profile.

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