Retirement Reality Check: Why You Should Start Investing Now

Retirement planning is an important aspect of financial wellness. It is essential to start planning for retirement early on to ensure a comfortable retirement. While it may seem daunting, there are many benefits to investing and planning for retirement. Firstly, it helps to maintain financial security and reduce worries about running out of money. Secondly, it can lower stress levels and improve physical and mental health. Additionally, retirement planning can help individuals make better career and financial decisions, improve their marriages, and avoid becoming a burden to their children. Furthermore, investing in a 401(k) or IRA can provide tax benefits and help individuals take advantage of compound interest. By starting early and seeking guidance from financial advisors, individuals can make the most of their retirement years.

You shouldn't rely on Social Security

Social Security benefits are often not enough for retirees to live on comfortably. They are intended to supplement retirement income, not replace preretirement earnings. The average monthly benefit is about $1,706, which may not be sufficient to cover living and healthcare costs, especially with prices on the rise. As a result, individuals may need to rely on other sources of income, such as pensions or savings, to maintain their pre-retirement standard of living.

Social Security benefits also lack flexibility when compared to other retirement accounts. For example, individuals cannot withdraw all the funds at once or take out loans against their Social Security balance. This lack of flexibility can impact an individual's ability to afford large-ticket items or unexpected medical bills during retirement.

In addition, the future of Social Security benefits is uncertain. Due to a drop in the birth rate, the program's costs are now higher than the revenues funding it. The Social Security Administration predicts that the program's trust fund will run out by 2037, after which only 76% of scheduled benefits will be payable. This uncertainty underscores the importance of having additional savings, such as a 401(k) or an IRA, to ensure a comfortable and secure retirement.

Furthermore, Social Security benefits may not keep up with inflation over time, eroding their purchasing power. This means that even if individuals receive their full benefits, the value of those benefits may not be enough to maintain their desired standard of living. Therefore, it is crucial to have a comprehensive retirement plan that does not rely solely on Social Security benefits.

While Social Security can provide a supplementary source of income during retirement, it should not be the primary source. By saving and investing in other retirement accounts, individuals can ensure they have sufficient funds to cover their expenses and maintain their desired lifestyle during retirement.

You may not want to burden your dependents

If you have children, you probably want to spend as much time with them as possible. However, you may not want to be living with them because you can't afford to live independently. This is not how most people want to spend their retirement years.

Living with your children because of financial difficulties may also put extra strain on their family and may cause them to miss out on financial opportunities of their own.

Additionally, if you become dependent on your children, you may also become a member of the "sandwich generation". This is the name for the group of people who are simultaneously supporting their children and their parents.

A comprehensive retirement plan includes saving for medical costs and potential long-term care costs. When you know your expenses are covered, you won't have to rely on your family to fill the gap.

You may miss out on tax benefits

When it comes to retirement, it's important to consider the tax benefits of investing early and often. Here are some reasons why you may miss out on tax benefits if you don't plan for retirement:

• Tax-deferred retirement accounts: Traditional IRAs and 401(k) plans are tax-deferred accounts, meaning you get an upfront tax break when you contribute. You only pay taxes when you withdraw the money in retirement. The longer you wait to contribute, the more you may miss out on this benefit, as these accounts have annual contribution limits.
• Tax-exempt retirement accounts: Roth IRAs and Roth 401(k)s are tax-exempt accounts. You contribute with after-tax dollars, but your investments grow tax-free, and qualified withdrawals in retirement are tax-free. By waiting to contribute, you miss out on the tax-free growth of your investments over time.
• Employer matching contributions: If your employer offers a retirement plan, such as a 401(k), they may also offer matching contributions. This means they will contribute a certain amount based on your contributions. By not contributing, you are missing out on this additional benefit, which is essentially free money.
• Compound interest: The earlier you start saving for retirement, the more time your savings have to grow. Compound interest means that you earn interest on both your initial investment and the interest it generates over time. This can lead to significant growth in your retirement savings, and by waiting, you miss out on potential gains.
• Tax credits: Depending on your income and filing status, you may be eligible for tax credits when you contribute to a retirement account. For example, lower-income earners may qualify for the Saver's Credit, which can further reduce your tax bill. By not contributing, you may miss out on these valuable tax credits.

In summary, by not investing for retirement, you may miss out on valuable tax benefits such as upfront tax breaks, tax-free growth, employer matching contributions, compound interest, and tax credits. These benefits can help maximize your retirement savings and reduce your tax burden in the long run. Therefore, it's important to start planning for retirement as early as possible to take advantage of these tax benefits.

You may miss out on the effects of compounding

Compounding is the process in which an asset's earnings are reinvested to generate additional earnings over time. This is often referred to as "interest on interest" and is considered the "miracle of compounding".

Compounding differs from linear growth, where only the principal earns interest each period. The effects of compounding strengthen as the frequency of compounding increases. For example, an investment of $1 million earning 20% per year with annual compounding will result in a future value of $1,200,000. However, if the same investment compounds quarterly, the future value increases to $1,215,506.

The power of compounding is evident when comparing simple interest to compound interest. In a simple interest scenario, an initial investment of $100 earning 5% interest per year will result in a total interest received of $50 after 10 years, with an account balance of $150. In contrast, with compound interest, the total interest received after 10 years increases to $62.89, resulting in an account balance of $162.89. The longer the compounding is allowed to work, the greater the impact. After 20 years, the compound interest scenario results in 32.7% more money, and after 30 years, it results in nearly 73% more money.

The concept of compounding is crucial in finance and is the motivation behind many investing strategies. For example, dividend reinvestment plans (DRIPs) offered by corporations allow investors to reinvest their cash dividends to purchase additional shares of stock, compounding their returns.

Compounding can also work against you when it comes to debt. For instance, if you owe compound interest on a credit card with an 18% annual interest rate, your debt will increase by 18% every year. Therefore, it is essential to understand the effects of compounding and how it can impact your financial decisions, whether it is saving for retirement or managing your debt.

You don't know what you don't know

Retirement planning is important, but it can be daunting. There are thousands of factors that can impact your financial security, and it's challenging to know where to start.

You probably know a lot about many things in life, but when it comes to retirement planning, you don't know what you don't know. This lack of knowledge can make it difficult to identify critical questions and answers that contribute to a successful retirement.

• What important tax, savings, and investment information should I plan around?
• What accounts should I consider if I want to save more?
• Am I eligible for social security benefits as a spouse?
• Should I consider doing a Roth conversion?
• What issues should I consider during a recession or market downturn?
• Should I rollover my dormant 401(k)?
• What financial issues should I be aware of before the end of the year?
• When should I take social security?
• Do I still need life insurance?
• What's the right mix of mutual funds or investments for me?
• Should I take my pension as a lump sum?
• How much income can I generate from my portfolio when I retire?
• Which retirement accounts should I draw from first?
• How can I reduce volatility in my portfolio?

Retirement planning can help address these unknowns and provide a roadmap for a secure financial future. It's important to start planning early, as the longer you wait, the more difficult it becomes to ensure a comfortable retirement.

• It can help reduce stress and improve your physical and mental health.
• It can lower your tax burden during retirement.
• It provides context for making better career and financial decisions.
• It can strengthen your marriage by aligning financial priorities and goals.
• It prepares you for unexpected early retirement.
• It ensures you won't be a financial burden to your children.
• It enables you to be financially supportive of your grandchildren.
• It allows you to continue your legacy of charitable giving.

Frequently asked questions