You don't need to be an investment expert to begin building a nest egg for retirement. Consistently saving a modest amount and investing it in a low-cost fund can lead to impressive gains over time. If you qualify for tax breaks and employer contributions, you can grow your retirement savings even faster. Here are five simple ways to create wealth for the future.
The power of compound interest. Saving a small sum of money on a regular basis can grow to a significant amount if you leave the money to grow for several decades. If you save just $100 per month between ages 25 and 65 and earn a 5 percent annual return, you will have $148,856 after 40 years. While you would have personally saved $48,000, the other $100,000 was generated by compounded investment returns. "It's important to understand compounding and the increase it is going to generate," says John Pelletier, director of the Center for Financial Literacy at Champlain College. "If you have $10,000 and leave it alone, it can double every decade." That doubling calculation assumes an 8 percent annual return.
How to qualify for tax breaks. The federal government rewards workers who save for retirement with a lower tax bill. You can defer paying tax on up to $18,000 that you contribute to a 401(k) plan and $5,500 that you save in an IRA. For people age 50 and older, the contribution limits jump to $24,000 for a 401(k) and $6,500 for an IRA. Contributing to these accounts could reduce the income tax you owe by $1,000 or more, depending on your tax rate and the amount you save. "That money comes out pretax right out of your paycheck, so you are saving without really feeling that impact of less cash flow," says Christopher McLaren, a certified financial planner for Conscious Life Planning in Cincinnati. And if your adjusted gross income is less than $30,750 as an individual or $61,500 for a couple, you can additionally claim the saver's credit on your retirement account contribution. Depending on your income, the saver's credit is worth between 10 and 50 percent of the amount you save in a retirement account up to $2,000 for individuals and $4,000 for couples.
How to get your employer to help pay for retirement. The fastest way to build wealth is to earn employer contributions to your retirement account. Some companies contribute to a 401(k) plan on behalf of all employees or share a proportion of company profits with them, while others require workers to save a specific amount in order to qualify for a 401(k) match. If your firm is willing to match your retirement account contributions, you can build a nest egg for retirement much more quickly. Some companies provide dollar-for-dollar matches that allow you to double your money. "If the employer match is 2.5 percent, now you are at 5 percent just by putting 2.5 percent in," says Cliff Robb, a consumer finance and financial planning associate professor at the University of Wisconsin-Madison. "That's money that you could have that you won't have if you don't do it." Just watch out for company vesting schedules that might require you to spend a specific number of years with the company before you get to take the 401(k) match with you when you leave the job.
How to minimize fees on investments. Investment fees reduce the amount you earn on your investments. When selecting funds for your 401(k) or IRA, pay close attention to the expense ratio of each fund and aim to select low-cost funds that meet your investment needs. "There are investment options that are available that have extremely low fees," Robb says. "There's not a whole lot that you should ever pay more than 1 percent for." Your 401(k) plan is required to send you a 401(k) fee disclosure statement each year that lists the costs of each fund in your plan. This handy document reduces the need to comb through mutual fund prospectuses to figure out how much each fund costs to own. But also watch out for transaction costs and sales charges. Keeping costs low will help you to earn a higher return on your investments.
How to automate your retirement savings. Saving for retirement every month can be a chore, and it's tempting to skip contributions. Automating the savings process reduces the temptation to spend the money you should be saving for retirement and helps you take advantage of retirement savings tax breaks and employer contributions throughout the year. Most 401(k) contributions are withheld from your salary before it's sent to your checking account, and the tax break shows up in your check. If your employer doesn't provide a 401(k) plan, you might be able to directly deposit part of your paycheck in an IRA or myRA. "You should be putting aside -- with your employer match if you have one -- between 10 and 15 percent of your salary beginning in your 20s if you want to have a comfortable retirement," Pelletier says. "You don't really need to know how to invest. All you need is one diversified target-date maturity fund."
Emily Brandon is the author of "Pensionless: The 10-Step Solution for a Stress-Free Retirement."