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The dollar you save now has decades longer to grow than the dollar you invest in your forties. If you put that dollar in an IRA, the earnings grow in a tax-sheltered account.
Let’s compare these two scenarios:
- You start investing $2,000 per year at age 21 in an IRA and stop making contributions at age 30. With an 8 percent rate of return, your IRA will be worth $462,648 at age 65.
- In contrast, you begin contributing $2,000 per year to an IRA at age 31. With that same 8 percent rate of return, your IRA will be worth $372,204 at age 65
You don’t have to wait until you get a full time job to begin investing in an IRA. You can make a contribution based on earnings from part-time work or a summer job. If you open a Roth IRA and follow the rules, all of your withdrawals will be tax-free someday. If you invest in a traditional IRA, you get a tax deduction now but you’ll pay taxes on withdrawals after you retire.
Remember that, with very few exceptions, you'll have to pay the IRS a 10% penalty if you withdraw from either a traditional or Roth IRA before you reach age 59½.
The Impact of Inflation
Inflation makes investing for retirement more complicated, especially for younger investors. With an inflation rate of 3 percent, items costing $50,000 today will cost $121,367 thirty years from now. With an inflation rate of 4 percent, you’ll need $162,170 to equal the purchasing power of $50,000 today.
Conservative investments aren’t risk-free. They may leave you with less purchasing power, even though you make money on paper. Based on the historical performance of the market, investing in stocks and stock mutual funds gives you the best opportunity to stay ahead of inflation and not lose purchasing power. Unfortunately, history doesn’t guarantee that you’ll make money in the short run or for any time frame.
That's why it is so important to have a truly diversified mix of investments.
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