- I started contributing to my employer-sponsored 401(k) well before I had an idea of what I wanted my retirement to look like.
- Looking back, I’m glad I started early. The longer my money sits in the market, the more interest it earns over time.
- And while retirement accounts have a reputation for tying up your money for decades, there are various exceptions to the rules.
- Sign up for Personal Finance Insider’s email newsletter here Â»
Saving for retirement can feel like the furthest thing from a priority in your early 20s.
But after working at Business Insider full-time for over a year, I decided it was time to set aside part of my paycheck in my company-sponsored 401(k) when I was just 24.
I didn’t have grand plans for retirement, but I was newly assigned to the personal-finance beat. The piece of advice I heard most often from experts in interviews was to “save early and save often,” so I took it to heart.
It’s been almost four years since I made the first contribution to my 401(k). Now I’m a certified financial planner myself and I’d recommend just about anyone start saving early for retirement, whether in an employer-sponsored account or an IRA.
I say “just about anyone” because there are, of course, exceptions. If you can’t make ends meet on your current income or you’re up to your eyeballs in high-interest debt, investing shouldn’t be your top priority. But if you can spare cash in your budget each month â€” or better yet, make room for it â€” there are at least two reasons to consider investing it in a retirement account.
1. Compound interest is your friend
Time is the key ingredient to building wealth. With investing, time gives way to compound interest.
Imagine you have $US100 and earn an annual rate of return of 5%. After one year, you’ll have $US105. Now the rate of return is applied to $US105. Five per cent of $US105 is more than 5% of your original $US100 investment, so your money begins to grow exponentially. That’s compound interest.
Compound interest can work wonders even if you don’t add a dime to your original investment. The chart below illustrates how just one $US5,000 investment would grow over 35 years earning a 5% return compounded semi-annually.
That’s remarkable growth, but things aren’t as predictable in the real world. Markets move up and down all the time, rarely producing steady returns. That’s why it’s crucial to keep saving consistently, if you can. And if you haven’t started yet, it’s not too late.
A huge perk of 401(k)s is that an employee and an employer can contribute, supercharging the potential for growth. A common way employers add to a 401(k) is through contribution matches. For example, my employer puts the same amount of money into my 401(k) as I do, up to 3% of my salary annually. To date, about 18% of my total 401(k) balance is attributed to employer contributions and subsequent investment gains.
In addition to my 401(k), I save for retirement in a Roth IRA. This type of account is funded with after-tax contributions, as opposed to the pre-tax contributions of a 401(k), and enjoys the same compound interest benefits, plus more flexibility around withdrawals.
2. Retirement is flexible
A lot of people have a fairly cookie-cutter image of retirement: stop working at 65, pick up a hobby or travel, and live on a combination of lifetime savings (or pension funds) and Social Security.
The truth is that retirement can be whatever â€” or whenever â€” you want it to be if you start preparing early. I didn’t have a clear mental picture of what I wanted my retirement to look like when I started saving at 24, and I don’t have an exact plan now. But with two growing investment accounts, my options are open.
Tax-advantaged investment accounts that are designated for retirement, such as 401(k)s and IRAs, do have rules about when you can withdraw your money, but they’re more flexible than you might think.
You can withdraw contributions to a Roth IRA at any time, tax- and penalty-free. Earnings can be withdrawn under certain circumstances before age 59 and a half. While you can only add up to $US6,000 a year to a Roth IRA, and have to meet specific income thresholds to do so, it’s a good place to stash money for an early retirement if that’s your goal.
The rules around employer-sponsored accounts, like 401(k)s and 403(b)s, are more strict. You generally have to be over age 59 and a half to take money directly from these accounts without incurring penalties, but there are some exceptions.
- The rule of 55: If you leave your job voluntarily or involuntarily and you’re at least 55 years old, you may be able to tap into your 401(k) without paying penalties. You’ll still owe income taxes if the account is a traditional 401(k), but you won’t pay the additional 10% penalty on top of that.
- Rollovers: IRAs have more lenient withdrawal rules than most employer-sponsored plans. If you leave a job and roll your 401(k) into a traditional IRA or Roth IRA, you may be able to avoid a 10% early withdrawal penalty on certain distributions.
- SEPP arrangement: If you still hold a 401(k) at a previous employer, you can choose to take substantially equal periodic payments (SEPP) that last the longer of five years or the time until you reach age 59 and a half. There are three different formulas to choose from that determine the size of your payment.
The bottom line: Retirement accounts are full of tax advantages and other benefits that can really help maximise your savings. Don’t write them off because you aren’t sure what “retirement” means to you just yet.
Related Content Module: More Retirement Coverage
Tanza Loudenback, CFP
, is the personal-finance correspondent at Business Insider. She writes most frequently about saving money, planning for retirement, taxes, debt management, and strategies for building wealth.
Have a money question for Tanza? Fill out this anonymous form.
Business Insider Emails & Alerts
Site highlights each day to your inbox.