The Secret of Retirement Savings: You Can’t Make Up for Lost Time

When you prioritize a set of tasks, you probably often order them by deadline, right? The things that have to be done today get taken care of first, and the things that have to be done tomorrow go next, and so on.

Given that this system seems to work well for most tasks in our lives, it’s easy to see how people keep putting off saving for retirement. It’s so far off it seems like there will always be time later to work on it.

Another good reason we put it off is that we think it’ll make more sense when we’re making more money. This excuse is seductive because it sounds financially responsible: ”Saving for retirement right now doesn’t make sense for my budget, you tell yourself.

But here’s the truth about saving for retirement: You can’t make up for lost time no matter what your budget is. Today, we’re going to explain why this is so, and give you practical tips on how to save now. Right now.

Because, simply put, putting off saving for retirement is the worst thing you can do for the rest of your financial life.

Why the ‘Right’ Time Never Comes

Think about when you started your first job after college.

At that time, you might have been overwhelmed by student loan payments or determined to pay off the credit card debt you accumulated in college. Or maybe you were just focused on covering your rent and groceries.

Odds are, retirement ”which was four decades away was pretty low on your priority list. When someone graduates, they’re so busy celebrating their new employment that they don’t stop to think about retirement benefits through their new job, says Katie Brewer, a LearnVest Planning Services certified financial planner.

Let’s say you didn’t start saving for retirement then. What happens next? A year or two later, you’re due for a raise, and where does it go? To a nicer apartment, or a nicer car. The next raise goes toward your wedding or a down payment for a new house, and so on.

As you can see, it’s so easy to keep postponing saving for retirement. But what we’re about to show you next will blow your mind: Waiting to contribute when you make more money doesn’t make any financial sense.

Why You Can’t Make Up for Lost Time

Let’s say you’re 25 and you want to have $1 million when you retire 40 years from now. If, over time, the market returns, on average, 7% a year, you’ll only need to save about $5,009 a year—$200,360 total—to get to your goal. You make $35,000 a year, so setting aside about $5,000 a year (more than $400 a month) sounds impossible, and you’re probably tempted to delay saving for retirement until you start making more money.

But think about this: Contributing $5,009 a year right now will leave you about $30,000 a year to live on. But if you wait until you’re 45 and making more money—let’s say, $60,000 a year—and start contributing then, you’ll have to contribute $24,393 a year to get to your retirement goal of $1 million! And that leaves you $35,607 a year to live on—at age 45.

But if you had started at 25, you would still be contributing just $5,009 a year at age 45, so you would have almost $55,000 a year to live on—not bad.

So now, when would you like to scrimp? When you’re young, all your friends are in the same boat and you have almost no responsibilities? Or when you’re 45, have two children and are dreaming of a beach house? (And if you’re already 45, then start now, rather than at 55!)

Why Time Is So Crucial to Growing Your Retirement Savings

As you can see, starting early makes saving for retirement a lot easier. Why is that? Take Charles and Katie. Both of them put $24,000 into their retirement accounts over the years, but Charles began saving ($50 per month) at age 25, while Katie began saving ($100 per month) at age 45.

Even though they both put in the same total amount, Charles will have almost twice as much money at retirement as Katie will when they reach age 65. Why? His money had more time to grow, so it was able to accumulate much more than Katie’s money.

The reason time gives such a big boost is because of something called compounding. For instance, let’s say someone invests $2,000, and the investment grows 7% a year. After one year, they’ll earn $140. The next year, they’ll earn $149.80. The almost $10 extra comes from the fact that the $140 they earned the year before will itself also earn 7%.

After 10 years, assuming that the investment grows at exactly the same rate every year (it doesn’t happen like that in real life, but usually does on average over time), that $2,000 will have grown to $3,934.30. In 20 years, it will be $7,739.37—not because any money has been added, but simply because the money has had more time to grow.

How to Save Right Now

But look—if you didn’t start saving with your first job (and by that, we’re including first job ever, because even high school students earning money can open a Roth IRA), don’t beat yourself up about it. Instead, just make sure you get on track now, with these tips.

1. Look into your employer’s retirement program.

The first thing you want to know (after confirming that your employer does have a program), is whether or not your company gives you a match. What’s a match? It’s free money. But your company will only give you that free money if you do two things:

  1. Save for retirement in your employer-sponsored account—most likely a 401(k) or a 403(b).
  2. Contribute a certain minimum amount—usually a percentage of your salary.

Here are some common ways matching works: Maybe your employer says it will give you “a 50% match up to the first 6%.” That means that if you contribute 6% of your salary, your company will pitch in 3%—and you’ll end up saving 9% of your salary, even though you yourself are only putting in two-thirds of it. What’s even better? Some companies offer a dollar for dollar match, though that is usually capped at a certain percent.

However your employer’s plan works, just make sure you are doing what you need to do to get the full match.

2. Open an IRA.

After you get your match, you want to contribute any extra money you can spare for retirement to an IRA. Which kind? Our flowchart will tell you:

If a Roth IRA is right for you, then you’ll enjoy a big investing advantage. While you’ll pay taxes on the money you contribute now, you won’t pay taxes on any of the earnings—and from what you saw of how much investments can grow over time, that could be a lot of money that you never pay taxes on!

After you open your IRA, get on a plan to start contributing to it regularly. Even if you can only contribute $50 a month, do it. Gradually over time, work your way up to contributing the maximum amount per year ($5,500 for 2013, or $6,500 if you’re 50 or older). And, after you max out your IRA contribution, if you want to keep saving more for retirement, then put more money in your 401(k) or 403(b) up to that maximum ($17,500 for 2013, or, for those 50 and older, $23,000).

You’re also allowed to contribute to both a 401(k) and an IRA. If you have the means, the best way to save more for retirement is to max both out. As our flowchart will show you, if you’ve saved up to the limit in both, you can also save money in a regular brokerage account.

3. Don’t touch the money in your retirement accounts—until retirement.

If you can help it, never use your IRA or 401(k) money before retirement. If you do end up tapping it early (for most plans, “early” is before age 59½), you’ll not only lose out on all the earnings that money would have accrued over time, but you’ll also have to pay taxes and penalties for withdrawing that money early.

The best way to keep your retirement money intact is to build emergency savings worth at least six months of income and then use that in dire situations. Brewer says she’s seen people who are falling behind on their mortgage payments “take everything out of their 401(k) to make mortgage payments, but they may end up losing their homes anyway. Most people don’t know that a 401(k) is creditor-protected in most states, so if someone ended up going through bankruptcy, they could have kept the money in their 401(k).”

Also, if you switch jobs, make sure to roll that money over to your new retirement account. As long as you keep the money in a retirement account that is taxed the same way—i.e., moving money from your old 401(k) to a new 401(k), or completing an IRA rollover, you won’t pay taxes and penalties for moving it.

Start Now!

If you’re realizing you need to get a move on this retirement thing, then look into opening your workplace retirement account and an IRA.