When is receiving money not necessarily a good sign? This time of year many Americans are receiving refund checks from the IRS reflecting a possible return of your “free loan” to the government last year by over withholding taxes. Some view it as a savings whereas they would not have accumulated this money with traditional saving methods. Some taxpayers experience changes in their work schedule or family dynamics such as the birth of a child or divorce and neglect to change their withholding percentages. Regardless of the reason, Texas is one of the states with individual taxpayers receiving the highest tax refunds in the country averaging approximately $3,100, according to recent IRS data. Making your money work harder, so you can retire sooner should be among your top priorities when considering what to do with this new-found wealth.
Compound interest is interest added to the principal of a deposit or loan so that the added interest also earns interest from then on. This addition of interest to the principal is called compounding. Assume there are twin sisters Morghan and Reagan. Hardworking, conservative Morghan gets a job at 18 and puts $100 of every monthly pre-tax paycheck into an individual retirement account. Pretax is an important part to this scenario since that money will not be taxed in that calendar year. Investing it in the stock market with an assumption of 10 percent a year on average until she retires at 68 will allow her to retire with $1,396,690!
Reagan, who has been listening to her sister go on about her retirement account for 10 years, finally gives in and starts contributing $100 per month at age 28. At age 68 she compares her retirement nest egg with her sister’s and finds she only has $531,111 -- a nice sum -- but less than half of her sister’s. Had she even waited an additional 10 years -- she would have had a mere $197,392 at retirement.
According to investing legend Warren Buffet, he is predicting the long-term annualized return of the U.S. stock market in the early to mid 21st century at 7 percent. Keeping in mind this is a long term average over the span of 20 years or more, if you save a mere $100 per month you will be a millionaire in 58 years and 6 months, but just increase that saving amount to $400 a month and if you’re 25 now you will be a millionaire at age 64 -- just in time for retirement.
It’s easy for young adults to get carried away with the prospects of starting a career or growing a family, but with more than 35 percent of people over the age of 65 relying on limited Social Security reserves, young professionals should take advantage if they are getting a tax refund and open a Roth IRA. The uncertainty of U.S. Social Security presents an increasing need for alternative retirement solutions to comfortably fund the golden years ahead. Roth IRAs do require young adults to pay taxes now -- at possibly a lower rate -- instead of paying taxes upon withdrawal at a potentially higher tax rate as with traditional IRAs. Other advantages would include no mandatory distribution age and the freedom of investment choices including stocks, bonds, CDs, and mutual funds.
When it comes to personal finance, many of us find ourselves in a rut and seemingly unable to get out of our way and on to better results. The key is to learn something new and ask for help. Change often begins with admitting we can’t do it alone. Ask your certified Financial Planner to help move you forward financially. Feel free to email me with any questions at email@example.com.
Barbara Magor Deel is a certified financial planner and a chartered financial consultant with EFS Generation Income Planning in La Vernia.