One of the biggest questions about retirement is when to start saving. The idea to start saving for something 40 years in the future can be hard when you’re early in your career, sitting with a student loan and earning a small salary. Even though you might be in your early 20s and retirement may seem a long way off, it’s vital to start sooner rather than later. In conjunction with having youth on your side, you also have time on your side, which means your money can grow over a longer period.
Why start early?
Here are three reasons why you shouldn’t delay retirement planning:
- If you think about it carefully, when you’re in your 20’s you still have minimal financial obligations, making it the best time to set money aside. You’re probably still free from expenses such as childrens’ university fees or a home loan.
- Retirement savings offer some tax benefits that will lower your tax expense. Many companies offer a pension benefit plan as part of employee benefits, where both you and your company contribute towards your retirement. These contributions can be subtracted from your gross income, thus lowering the total amount you’ll need to pay tax on. If your employer doesn’t provide some sort of pension funds benefit, a Retirement Annuity (RA) is a great way to invest for the future, as any interest, dividends and capital gains earned are tax-free. This is a long-term investment vehicle, provided by many financial institutions in the country. In order to benefit from tax benefits, you can contribute up to a maximum of 27.5% of your income or R350,000 per year (whichever is less).
- The longer you invest your money, the bigger your nest egg at retirement will be. If you start early, you can afford to put away less, as you’ll be earning ‘’interest on interest’’ for the coming years. This phenomenon is better known as compound interest — the main reason to start early with retirement planning.
The miracle of compounding
If you’re unfamiliar with the phrase, it’s interest earned on your initial invested amount as well as the accumulated interest from previous periods. The more the number of compounding periods, the quicker you can reach your investment goal.
To get the basics right, let’s look at two examples:
Example 1: this shows the importance of starting with retirement planning straight away. If someone was to invest R500 per month and earn an annual return of 7%, this is how much money they would have at retirement age based on when they start:
Example 2: Let’s look at the difference between compound and simple interest.
Paul invests a once-off sum of R500 000 for 5 years at an annual simple interest rate of 7%. This means he earns 7% interest on the initial R500 000 only:
Liz invests a once-off sum of R500 000 for 5 years at an annual interest rate of 7% compounded. This means she earns interest on the initial R500 000, plus the interest that gets reinvested as soon as it’s earned:
Retirement planning is an ongoing process where you need to regularly update your retirement objectives as your financial situation changes. If you start early, you can afford to put away less as you’ll be earning ‘’interest on interest’’ for the coming years. If all of this is a bit overwhelming, you can always approach a financial adviser to help you map out a retirement plan.
Written by Marnia