How much you contribute to your retirement account now makes a big difference over time.
When you’re young and have decades until you retire, your biggest asset is time. You may not have a lot of money, it may seem like years before you can buy a house, but it’s in your best interests to contribute as much as you can towards retirement because you have so much time ahead of you. Those years pass by faster than you think and before you know it, you’ll be tapping those funds!
For those closer to retirement, hopefully by the time you reach your 50s and 60s you are in pretty good shape. It’s most important at this age to stay the course with your investment strategy. Don’t make rash decisions or be influenced by volatile markets. If retirement is not far away, check in to ensure your level of risk is appropriate for your shorter time horizon.
Compounding is Significant
The more you put in, the more you end up with in interest and appreciation. Compound interest can practically work miracles. However, the more you have in principal, the faster the interest grows. As you max out your retirement account, your money will work better on your behalf.
Consider that $10,000 appreciating 8% a year for 20 years will be worth over $46,600. If you manage to get a 10% growth rate, now we’re talking almost $67,275. The more you can contribute today, the longer it has to grow and the more you’ll end up with.
Big Tax Benefits
Contributions to a 401(k), 403(b), and Traditional IRA are tax deductible because the accounts are tax deferred. You pay taxes when you take disbursements in retirement, which means you pay less in taxes today and a larger portion of your income gets to grow during that time.
Roth accounts are not tax deductible but they are tax free. Your money will grow tax-free, so maxing out your account means that you end up with more tax-free money in the long run.
Run the numbers to see if you would benefit more from a Traditional account and an immediate tax benefit, or if you would do better to take the long-term benefits offered by a Roth account.
Personally, I like to get a mix of tax deferred and tax free contributions because you never know what will happen with taxes. That type of diversification can be useful.
Know Your Number
The maximum you can contribute to a 401(k), 403(b) is $18,000 in 2015. The catch-up contribution limit for people age 50 or older remains at $6,000.
You can also contribute more to your IRA. For both traditional IRAs and Roths, the maximum you can contribute is now $5,500 (the catch-up contribution is still $1,000 for people age 50 or older, bringing their total to $6,500). You can read up on the details on the IRS website: 2015 Retirement Account Contribution Limits.
Building to the Maximum
Most of us can’t just start contributing the maximum immediately. However, it’s possible to build up to a maxing out your retirement contributions for the year. You can grow your contributions by increments. If your employer offers a match, do what you can to get the maximum match. This is free money that can be used to build your retirement nest egg.
Your first step is to honestly audit your spending. Could you cut out some of your expenses and then apply the savings to your retirement account? Chances are that you probably can. Look for an extra $50 or $100 in your budget for the month, and start adding that to your regularly retirement contribution.
Don’t just stop with cutting expenses, though. Figure out how much you need each month to max out your contributions, and make that number your goal. If you can’t cut expenses enough to max out your contributions, look for ways to earn more money. Start a side hustle, get a part-time job, or consider asking for a raise.
Maxing out your retirement contributions is a good way to ensure you are building wealth for the future. Plus, it allows you to get the best bang for your buck. You end up with the potential for more earnings as your balance grows, and you also receive tax advantages.
New to Betterment? As the most trusted online financial advisor, Betterment offers a fully diversified investment portfolio of 12 global asset classes, optimized to provide you the best possible returns for both retirement planning and wealth building. Betterment costs 0.15% of assets under management annually for a portfolio of $100,000 or more. Learn more here.
This article was published on January 21, 2013
Was this article helpful to you?
Our newsletter is full of tips to help you lead a smarter financial life.