We all decide to start saving for retirement at different ages in life. But whatever age you decide to start, understand this: there will be a cost of waiting to save for your retirement. The cost will come in the form of either a smaller retirement portfolio, increased funding requirements later in life, or both.
There’s a specific reason why this is true.
Those Who Start Early Finish Wealthier
There’s no mystery here, saving for retirement is something of a race, and the faster and stronger you come out of the gate at the start of the race, the better you’re likely to finish. A parallel analogy is home ownership. The sooner you buy a home, the faster and greater your accumulated equity will be. This will happen since your house will have more years to appreciate in value, and you will have more time to pay down your mortgage. Your equity will increase as a result of both forces.
So it is with retirement. The time value of money is the primary reason — and we’ll get deeper into that in a bit. But for now it’s best demonstrated by a couple of examples.
For simplicity’s sake, we’ll assume IRA accounts-only for the examples, so that we don’t have to account for employer matching contributions.
Example #1 – Starting Early and Saving Longer
Mary and Jane are both 25 and earn similar income levels. Mary decides not to delay saving for retirement and begins funding her IRA at the maximum level — $5,500 per year. Assuming an 8% average annual rate of return, Mary will have $1,485,816 accumulated in her IRA by the time she reaches age 65.
Jane decides that she wants to delay funding her retirement until “life is more settled”. But the years pass quickly, and before she knows it, she’s about to turn 40 and has no money set aside for retirement. She begins funding her IRA when she finally turns 40, also doing so at the maximum level of $5,500 per year, and also with an average annual rate of return of 8%. But by the time Jane turns 65, she will have only $419,298 in her IRA.
That’s a large difference! The point is: Mary will have more than Jane at age 65 by more than $1 million as a result of starting her retirement savings regime 15 years earlier.
Example #2 – Starting Early Then Stopping
Let’s take the same two women, following the same respective paths as in Example #1, but with one significant change: Though Mary begins funding her IRA at age 25, she decides to stop doing so at age 40.
Will that change the result? Only as a matter of degree. Mary still comes out on top, and by a wide margin again.
As in the example above, Jane will accumulate $419,298 by age 65 as a result of starting her savings plan at age 40.
Mary will fund her IRA — at $5,500 per year — but stop when she turns 40. At that time, she will have already accumulated $155,731 in her account, which will earn an average annual rate of return of 8% per year through age 65. With just the earnings on her IRA balance — and no additional contributions to the plan for 25 years. Mary’s retirement nest egg will grow to $1,066,520 by the time she turns 65.
That’s not as good as the nearly $1.5 million she would accumulate if she continued her plan contributions through age 65, but it’s still more than $600,000 more than Jane will have.
And here’s the unkindest cut: Jane will have contributed more to her IRA than Mary will, even though Mary still ends up with far more money.
Mary’s 15 years of contributing $5,500 per year (from age 25 to 40), will total $82,500.
Jane’s 25 years of contributing $5,500 per year (from age 40 to 65), will total $137,500.
And still Mary ends up with far more money.
Retirement Reality: The Time Value of Money
In both examples, Mary comes out ahead of Jane, regardless of the amount of contributions made. In fact, the comparison isn’t even close! The “magic factor” is the 8% average annual rate of return, or more specifically that Mary had the benefit of earning it for an extra 15 years in either case.
That’s the time value of money, and it’s virtually the most important factor when it comes to retirement planning.
By starting your retirement savings plan as early as possible, you create an almost insurmountable advantage over virtually any other strategy, short of dooming yourself to making substantially higher contributions later in life.
If you started saving for retirement early in life, you’re probably already reaping the benefits of the early start. And if you haven’t begun saving yet, today is an outstanding day to get started.
Don’t put off saving for retirement, because it will cost you more than you’re willing to pay later in life.