The Importance of Early Retirement Savings

Saving for retirement is like eating spinach.  Everyone knows they should be eating it but people do not like to do it.  Here I will talk about the benefits of saving for retirement, especially at a young age.

First take a look at this graphic (the amount that would be saved by age 60):

This table has a lot of important information.

First, regardless of the yearly return, the earlier a person starts to save for retirement the more money they end up with.  There is nothing like the power of compounding interest. 

Second, the difference between saving $1,000 and $5,000 a year is huge.  It is inexcusable to save less than $2,000 a year because there is a retirement savings credit for that amount if a person has a low income.

Third, the difference between a 5% and 10% annual return is staggering.  For a person saving $5,000 a year from the age of 25, a 5% return would yield $451,602 by the age of 60 while a 10% return would yield $1,355,122 by age 60.  That is almost a $900,000 difference. 

It is not unreasonable to assume a 10% return.  Over the last 100 years, small caps have averaged around 15% a year while the stock market as a whole has held around 10% a year.  Even a somewhat conservative allocation including bonds could still yield 10% over the long run.  For people under 25, the difference between 0 and 1.4 million for retirement is as little as $5,000 a year.

There are 3 main ways to save for retirement, each with its own advantages.

1. The ROTH IRA
It is universally accepted that this is the better of the two types of IRA.  The basis of the Roth is that income will be taxed when it is entered into the account but not when it is withdrawn.  This means that the 1.4 million dollars as discussed above would be tax-free.  This type of account is best served for people who save their favorites food for last.  It makes sense to eat your carrots first because you know you've got some delicious chocolate chip cookies waiting for you.  The Roth IRA is the delicious chocolate chip cookie.

2. The Traditional IRA

The benefits of the traditional IRA is the tax benefits immediately.  People below certain AGI limits can deduct up to $5,000 on their tax return.  On the downside, this money then has to be taxed when it is withdrawn. 

3. The 401(k)
ALWAYS ALWAYS ALWAYS put money into the 401(k) first up to the amount the employer matches.  If your employer matches half of the first $3,000 put into the account, you have earned a free $1,500.  There are no sure things in investing except for the employer 401(k) match.  Take advantage of it if you can!

I hope this helps with the retirement dilemma.
Remember, $5,000 a year, retire without fear