A Simple Formula for Painless Retirement Savings

By Michele Lerner

If you're new to the work force, you probably aren't thinking much about retirement because it seems so far away. And anyway, you may be thinking, where in the world am I going to get those hundreds of thousands of dollars? Relax and start small! The sooner you start saving, the faster your savings will grow.

"Pay yourself first" has long been the mantra of financial experts, but when the credit card bill, the car loan and the mortgage payment are all sitting on your desk and glaring at you, it can be tough to remember that mantra. One way to be a successful saver, though, is to establish a system that skims just a little bit of your income off the top and sweeps it into a savings account or a money market account before you even know it's gone.

Two approaches to savings

According to Walter Updegrave, senior editor of Money Magazine, there are two basic approaches for a savings plan. One approach is to develop a budget and track your spending, looking for places to cut back and putting the savings into a high interest savings account after comparing rates.

The second approach is simpler: choose a target savings rate, such as ten percent, and have that money automatically deposited into a savings account or a money market account from every paycheck.

How much to save for retirement

According to the Bureau of Economic Analysis, Americans saved 5.8 percent of their after-tax income in August, up from 5.7 percent in July and considerably more than the typical rate of one to three percent that was common in the years before the recession.

How much should you save? While 5.8 percent is better than not saving at all, many financial experts recommend that you save ten percent or, if possible, as much as twenty percent. The Balanced Money Formula suggests allocating twenty percent of your income to savings, thirty percent to "wants" and fifty percent to "needs".

The percentage of your income that you save depends on your age and other factors in your life, such as whether you are paying off debt and college tuition bills or whether you already have investments in place for your retirement.

Maximizing your savings

As soon as you establish a savings pattern, you need to maximize your savings with an account that earns the highest savings rates. Compare online the interest paid on savings accounts, money market accounts, certificates of deposit (CDs) and interest checking accounts so that every dollar you save will earn as much interest as possible.

If your employer offers matching funds in a 401(k) plan, make sure you are at least saving the maximum your employer matches.

Put compound interest to work on your savings

Whether you are starting out in the workforce or are already dreaming of leaving it, you can take advantage of compound interest. Compound interest has the biggest impact for those who save the longest and for those who save the most money. For young savers, earning interest over decades can add thousands to their retirement fund. For older savers, the interest earned on large sums of money can accumulate quickly.

For example, if you're 25 years old and you start putting aside $200 every month in a high interest savings account, earning an average of 3 percent and compounded monthly, you'll have more than $185,000 pre-tax by age 65. If you wait until age 40 to begin saving $200 a month, you'd only have $89,000 by age 65 if you earned the same rate of return. Clearly, it pays to start saving early.

The cost of waiting

If you're starting at age 40 and you still want to end up with $185,000 pre-tax at age 65, you'd have to more than double your savings rate to $415 per month (again assuming a three percent interest rate compounded monthly).

While it's always best to start saving for retirement as soon as you can, it's never too early -- or too late -- for you to start a retirement plan that can lead to a more secure financial future.