The Secure Act of 2020 increased the age for required minimum distributions from your retirement account to 75. You’ll have fifty years to save if you start to plan for retirement when you’re twenty-five. That’s half a century of stock market returns, interest payments from your bank, and 401(k) contributions. Here are five reasons why that’s good for you:
1. Compound interest
Compound interest is the best friend of anyone who starts saving for retirement early. When given enough time to grow, simple investments like savings accounts and bonds can earn significant amounts when the interest compounds annually. That means each interest payment increases the balance you’ll earn interest on the following year.
Here’s an example. Let’s say you invest $1,000 into a savings account with a 3% compounded annual interest rate. In the first year, you’ll earn $30 in interest, bringing the balance to $1,030. The next year, you’ll earn interest on that, a total of $30.90. It grows reciprocally. In year 40, you’ll earn $95 if the interest rate stays at 3%. It could go up, increasing your earnings.
2. More aggressive investment options
Investors in their sixties need to be more cautious with their investments because they can’t afford to take losses. Younger people can take more chances. They can afford to invest more aggressively because the stock market generally produces a 10% return when given enough time. Volatility is a short-term phenomenon that passes if you have the years to ride it out.
Being aggressive does not mean holding losing stocks when they have no chance to recover. This is where an investment advisor or financial planner can help you.
3. Higher investment returns
Higher returns are never guaranteed, but they are more likely when you can hold growth stocks and alternative investments as part of a balanced portfolio. The additional years you’ll have to add funds to that portfolio makes this possible. Combine compounded savings accounts, low-risk bonds, and medium to high-risk equities or alternatives for the best results.
It’s best not to do this on your own. Balancing an investment portfolio is a job for professionals. Robo-advisors and retail platforms can do it for you if you want to pay the management fees. Do some research and try to stay current on new investment trends to remain informed.
4. Reduced income taxes
Contributions to a 401(k) or traditional IRA are tax-deferred. They lower the amount of income you’ll need to pay taxes on while you’re working. In retirement, you’ll be in a lower income bracket, so the tax rate on distributions from those accounts will be lower. Returns on your retirement accounts will be taxed as you withdraw them, not while they’re accumulating.
Another option for retirement savings is a Roth IRA. Contributions to a Roth are made after taxes, so distributions in retirement are tax free. Taxpayers can contribute up to $6,500 into a Roth IRA per year. Doing that every year from age 25 to 67, assuming just a 6% return, will produce a net sum of $1.21 million in tax-free retirement income.
5. Employer contributions
Many employers offer 401(k) contributions as part of their benefits packages. Take advantage of those. It’s basically free money that will earn returns for you early in the retirement savings process. Maximize your own contributions to get the most out of theirs.
If you’re weighing competing offers from multiple companies, look for cash matches over stock matches on your retirement plan. Stock matches generally need to vest over time, and you may not be able to take them with you if you leave the company. Cash matches are yours from the moment they’re given. If you leave, you can roll them over with the rest of your funds.
The Bottom Line
Planning for retirement early can lead to early retirement or a higher retirement income if you wait and retire in your 60s or 70s. It’s best to make it a priority when you’re young. Look for savings accounts and bonds that compound interest, be more aggressive with investments to generate higher returns, take advantage of tax breaks while working and in retirement, and max out your own 401(k) contributions to get the best match from your employer.