What is more important than paying off debt? As it turns, out saving for retirement starting as early as you can and with as much as you can afford to save. I will show you some figures a little later that will make you see the way of the future. Now some of you may already be saving for your retirement, but there is a way for parents and grandparents to help important children to them by setting up Individual Retirement Accounts in their names and watch the funds grow in ways most people can never imagine.
Now, let us look at three individuals who are all the same age but however start saving at different points in their lives. All of our savers will be saving $5,500 a year with an average return of 8% a year which is about what the stock market returns over a long period of time. Nancy starts saving at age 25 and after ten years has saved a little over $86,000 at age 35. But Nancy does not touch the account until she is 65 which means there is another 30 years of the money growing and earning extra for her while she does not contribute an extra dime to the account. By the time she is 65, she will have over $865,000 in the account.
Donald starts saving at age 35 with the same restrictions as Nancy but will only have $401,000 accrued by the time he reaches age 65 with just ten years on contributions. But Paul started saving for his ten-year period at age 21 and by the time he reaches age 65, he will have over $1,100,000 in his retirement account. By waiting 10 years to start Donald will have less than half of what Nancy has and Paul will have almost a third more than Nancy. Just by starting four years earlier than Nancy it makes a huge difference in the amount that is accumulated in the account by age 65.
So as you can see by delaying payments on debts and starting to save for retirement, it can have some significant outcomes. Now let us say we all start at the same time but instead continue to contribute the $5,500 on an annual basis. We will look at Donald first as he starts saving last. He will contribute for 30 years and end with an account balance of just over $672,000 when he retires. Nancy starts at age 25 and will save for 40 years and end up with over $1,500,000 at age 65. Paul starts just four years earlier and will save for 44 years and end up with an outstanding $2,100,000 in their retirement account. The more time you give your money to grow the better off you will be later in life.
Now I advocate for a ROTH account over a traditional retirement account especially if you are younger and just starting out in your work career. The reason for this is you are in a lower tax bracket when you are starting out, and the tax deduction is not as valuable as it may be later in your earning career. That and I think with the current political environment and the shape of the government taxes will not be going down over the long haul. So getting a large sum of money tax-free in retirement is the way to go in my book.
As for paying debt versus saving for retirement, there are different approaches to that train of thought. Of course, if your debt is of the high-interest rate variety such as credit card debts I think that those need to be paid down as fast as possible while still saving for retirement if possible. But lower interest rate debts such as mortgages and student loans are a different bread. Here you may get some tax advantages on these lower interest rate debts that make stretching the payments out more to your advantage. To a degree that is and it is always smart to think long term and consider all aspects of your situation before making a financial plan. Just because something is tax advantaged does not mean you should ignore paying off the debt as fast as possible because you may not always be saving that much money. It is wise to run a cost analysis on such debts and their repayment to see if it is advantageous to pay it off or save for retirement. This is where a fee-only financial planner may be beneficial to have close at hand.
People need to weigh the benefits of saving versus the benefits of paying off debts. He is a fast way to determine which may be the better way for you to go. On average, the stock market has returned about 8% a year if your debts cost less than 8% a year, and are tax advantaged the benefit to you will be to invest for your retirement instead of paying the debt and not saving for retirement. If your debt costs more than 8%, and are or are not tax advantaged, the benefit will be to pay off the debt. The exception to this are 401(k) accounts that have a form of company matching.
If your employer offers a 401(k) that has any sort of matching, always take advantage of that benefit. Most offer something like matching the first 3% you contribute with a 100% match on that 3%. That means for every 3% you save your company will match it with another 3% making a total saved in your name of 6% of your salary. For ROTH accounts this is done with post-taxed money and for traditional accounts, it is pre-taxed money. Again, personally, I like the ROTH option even in the higher tax brackets as I do not see my taxes going down when I retire.
So if you are young or have younger children or grandchildren, all I can say is save some money in an IRA for them as soon as you can, as often as you can and for as long as you can. The only requirement for saving in an IRA for children is that they have earned income to put in the account. Now the money does not have to be theirs as you can contribute for them, but only up to either the amount they earned or for 2016 $5,500.
If you have any questions or need any additional information, feel free to contact me or leave a message.
