Tuesday, 13 Mar 2012

The Importance of Saving Early for Retirement

This is a guest post by Ellen Davidson.  Ellen’s passion for reading, senior care and research studies has allowed her to pursue a career in writing. She is currently a staff writer for a Senior Living Information site.

In these tough economic times, the last thing about which many people are thinking is their retirement. With nearly 13 million Americans currently out of work, there is a large segment of the population that can not afford to save for retirement. In addition, many people who do have jobs have struggled to just make ends meet: real wages have hardly grown at all in the past decade.

These difficulties have been reflected by the subpar returns of the stock market: in the first decade of the 21th century, equities gave investors a negative rate of return and underperformed most other asset classes. Given that stocks are generally the focal point of any asset allocation strategy for retirement, these numbers are very discouraging for people who want to save for the future.

In fact, the numbers are so discouraging that many people simply don’t save for the future. Despite the advice of many financial experts, who advise people to save at least ten percent of their income, the personal savings rate in the United States is just 4.6 percent. The average 401(k) balance is only $71,500, which is far short of the goal that most people need to reach in order to retire. Even worse, a majority of all Americans have less than $25,000 in total savings, which makes the possibility of retirement nearly nonexistent.

If you wish to avoid the fate of many of these people, it is essential that you begin saving earnestly for retirement as soon as possible. Over the course of 30 or more years, there is a decent probability that stocks will outperform bonds and other asset classes. Since 1928, stocks have had an average annual return of 9.2 percent, which is more than four percent better than the return from Treasury bonds.

Of course, stocks come with significant volatility, which is why retirement investors must have a long-term time horizon in order to benefit from higher expected returns. This fact helps to explain the importance of beginning your retirement planning early in your life. When you start saving for retirement at a young age, you increase your chances of earning a higher return on your investment. In addition, you allow your savings to compound for a longer period of time, which can significantly increase your nest egg as you reach retirement age.

Fortunately, the government has created a number of tax-advantaged savings accounts that makes retirement planning much easier. The most popular of these accounts is the 401(k), an employer-sponsored account that allows workers to save as much as $17,000 per year. Contributions to a 401(k) can be deducted from your income, which reduces your current income tax burden; however, your 401(k) assets will be taxed when you withdraw them during retirement.

This tax deduction provides a strong incentive to save for your retirement, but there are even better reasons to contribute to your 401(k). Many employers will match a percentage of the contributions of their employees. This is essentially free money and should not be passed up by anyone who is offered such a deal.

Of course, the 401(k) is not the only retirement account to which you can contribute. For instance, the Roth IRA has become a popular supplement to the 401(k) for retirement savings. Anyone with earned income can contribute up to $5,000 per year in a Roth IRA. Although contributions can not be deducted from your taxes, you can withdraw the money during retirement without any further tax liability.

Both the 401(k) and the Roth IRA should be used as part of an overall retirement strategy. By saving as much money as you can in these tax-advantaged accounts, you will increase your chances of amassing a nest egg that is large enough to pay for a comfortable retirement.

One Response to “The Importance of Saving Early for Retirement”

  1. Dale Simons Says:

    I wanna go shopping…but I need to save money #TORN