Of course, there are no guarantees about either the rate or the regularity of the earnings. They may be outstanding one year and dismal the next, or they may go through longer, but still alternating, periods of growth and decline. That’s the reality of investing. Having time on your side means that bumps in the road, like a period when investment prices go down and your account value shrinks, may be setbacks. But they don’t have to be fatal.
To show the impact of starting to invest as early as you can in a 401(k) or other retirement savings plan, compare the potential results if you began investing at different points in your working life. To keep matters simple, assume your employer doesn’t match your contributions and you put in the same amount each year you participate.
Remember that returns are not guaranteed. Your return could be low, and you could lose as well as make money.
401(k) Plan Started at Age 45
You decide to enjoy the money you have while you’re young, and you don’t start contributing to your 401(k) until you’re 45. If you contribute $5,000 a year and average an 8% annual return, you’ll have about $247,000 in your account if you stop contributing at 65, based on a total contribution of $100,000.
401(k) Plan Started at Age 35
When you reach 35, you realize it’s time to get serious about the future, so you start contributing $5,000 a year to your 401(k). Your investment return averages 8% a year. When you retire at 65, your account value will be about $611,000, based on a total contribution of $150,000.
401(k) Plan Started at Age 25
You start contributing to a 401(k) at 25, as soon as you’re eligible for a plan. You contribute $5,000 a year for 40 years until you retire at 65. Your return averages 8%, so your account value is almost $1.4 million, based on a total contribution of $200,000.
401(k) plans are the most common, and best known, employer-sponsored salary reduction plans. But they’re not the only ones. If you work for a not-for-profit organization such as a school or college, a hospital, a cultural institution, or a charitable organization, your employer may offer a 403(b) plan, which operates in much the same way as a 401(k).
Similarly, the plan a state or municipal government offers may be a 457 plan, while federal government departments and agencies provide a thrift savings plan (TSP). And if you work for a small company—one with fewer than 100 employees—you may be part of a SIMPLE plan, an acronym for Savings Incentive Match Plan for Employees.
The rules differ slightly for each type of plan, and even among plans of the same type. But all offer the opportunity for tax-deferred earnings.