No matter what your age, the bills you face today can make saving for longer-term goals like retirement seem like an impossible task. But even if you can manage to set aside just a few dollars per paycheck for retirement, the sooner you start, the more time your money will have to grow through compounding.
Compounding happens when your investment earnings attract more earnings, creating a snowball effect that makes your savings grow more rapidly. The effect gets magnified when taxes are deferred on earnings, which is what happens in a typical workplace retirement savings plan or an IRA.
Let’s look at Pedro and Noelle. They each invest $45,000 in their retirement plan over 20 years: $1,500 annually in years 1 through 10 and $3,000 annually in years 11 through 20. Pedro invests between ages 45 and 65. Noelle invests between 25 and 45, and then she stops adding savings to her account but leaves the account invested.
Here’s how much savings Pedro and Noelle would each accumulate by age 65, assuming they earn a constant average annual return of 6%. Both scenarios assume that contributions to savings are made at the end of each year and that no taxes are withheld from earnings.
| Total cash outlay |
Accumulated savings at age 65 |
|
| Pedro invests between 45 and 65 | $45,000 | $75,000 |
| Noelle invests between 25 and 45, then stops contributing to her savings but leaves her account invested |
$45,000 | $240,000 |
Noelle ends up with $165,000 more savings than Pedro, because her money gets 20 more years of compounded growth. Getting an earlier start on saving and investing pays off handsomely for Noelle.
The numbers for Noelle and Pedro don’t even account for contributions from their respective employers. If your own plan features matching contributions, try to contribute enough to the plan to get the full amount of the match. Otherwise, you’re forfeiting free money from your employer.
You may need to make additional employee contributions to reach your retirement goal even if your employer does not require employee contributions to receive employer matching benefits. Employee pre-tax contributions reduces your current tax liability. For clergy, employee pre-tax contributions are eligible for Housing Allowance tax exclusion at retirement.
However much you decide to save for retirement, start setting aside a little today, with the goal of increasing your annual savings contributions.
For more information or financial assistance, actively-contributing members of the Annuity Plan can call an EY financial planner at 1.877.927.1047.
This article is used with permission of Ernst & Young LLP.