Can We Retire Yet? Intro to Tax-Advantaged Savings

The Enemy of Fun reminds me on a fairly regular basis that I am still thirty years away from retirement… something I refuse to acknowledge or accept. I think he actually enjoys reminding me of this, kinda like how I like to ask him almost every day whether we can retire yet. And as much as we joke, planning for retirement is more of a focal point now than ever before (for me, obviously not for him).

As someone who didn’t start officially saving for retirement (or saving generally … awkward) until, well, like four months ago, I am going to grace you with all of my brand, spanking new retirement wisdom.

When it comes to savings, the first step is having an emergency fund – read all about it here. Once you have enough of a buffer saved up, you should be concentrating on what a lot of people call retirement savings… but I hate, hate, hate the idea of saving up for something that is literally so far away. I prefer to call this “tax-advantaged savings”.

Why should you save for retirement now?

Seriously, this was a struggle for me to really internalize and accept as a basic truth – but once I got there… I was all in.

There is one big, enormous reason to start saving as early as possible – compound interest (or as I like to call it – interest on interest on interest).

Remember the horrible way credit cards charge interest by charging interest on interest on interest on interest (details here)? This is similar but instead of benefiting a bank or credit card company, you are the beneficiary! The idea is that the amount of money you put in continues to earn interest on a regular basis and that interest is added to the principal amount in your account, while interest on that higher principal continues to accrue. Money on money on money, literally. Einstein supposedly called compound interest the eighth wonder of the world – even if that isn’t true, the point stands.

The diagram below (courtesy of JPMorgan Asset Management) tells the story of three individuals saving for retirement. All three invest different amounts at different points in their lives for various durations and the resulting numbers are mind blowing.

Chris invests the same amount every year for 40 years, while Bill and Susan invest that same amount annually for 30 years and 10 years respectively. What is surprising is not the fact that Chris comes out ahead, but rather that Susan – who only invested a third of what Bill invested – comes out $60,000 ahead of Bill!

And that, my friends, is the perfect illustration of compound interest. So please, for the love of Bill, start saving as early as possible.

How can I start saving right now?

Let me count the ways… literally, I will. I will be going through each of the main tax-advantaged savings accounts one by one, breaking down all of the details, tax implications, advantages, disadvantages, maximums, minimums, etc., etc.

I will focus on the American accounts available, primarily because that is what I know and understand. There are other similar tax-advantaged savings available in Canada, the UK and Australia so if you live in one of those places, definitely do your research!

The main American tax-advantaged savings accounts include:

  • Employer-sponsored 401(k) plan
  • Traditional IRA (individual retirement account)
  • Roth IRA

Starting tomorrow, I will be giving you all the dirt on 401(k) plans including how to maximize any free money your employer may be offering you! So stay tuned – your future, retired self will thank you!!

Sincerely yours in harmonious fun and fiscal responsibility,
Rachel

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