This article originally appeared on Nov. 20, 2020. It has been updated to reflect recent data and legislation.
Maybe you got a great graduation gift (congrats!). Landed your first “real” job (woo-hoo!). Scored a substantial bonus (lit!). Now what? Whether you’ve come into a big chunk of change or a small but steady income stream, you have a great opportunity to fund your future.
That’s because when you’re young, one of the most valuable things on your side is time. Time lets you invest even small amounts—and let compounding work its magic: As your investments earn money, those returns can earn even more, and so on.
The earlier you start, the more time your money has to compound—and the less you may need to invest to hit the same goal as you would if you sleep on it. With a long-term target like retirement, that’s a no-brainer.
So, how much money will you need to retire the way you’ll want? The answer depends on a ton of factors. Yet if you’re young, chances are it’ll include seven figures.
Now, a $1 million retirement nest egg might sound unattainable. But you can get there even if your current income is modest.
Compound interest can help grow your funds year over year through accumulative interest. For example, if you earn 5% yearly interest on $1,000, you’ll earn just over $276 over the course of five years. That might not seem like much. But imagine: If you invest an extra $1,000 per year for 50 years, you could save as much as $220,000. That’s why starting early is crucial to building your nest egg and even saving for other goals. Waiting may end up costing you in the long run, and compound interest can help you move forward faster.
When should you start saving for retirement?
The best time to start saving for retirement is now. It’s impossible to overstate the advantages of early saving and investing. When you start early, you can invest much less to potentially build the same nest egg you would if you start later. But it can be tricky to carve out the money for saving when you’re first starting out and may not be earning much money. Between student loans, rent, and groceries, you might not have much left at the end of the month to invest.
Fortunately, there are ways to make saving a little less painful:
- Tax breaks today … You’ll likely miss your money a lot less when it comes out of your paycheck before it’s taxed. “Traditional” workplace retirement accounts like 401(k)s are funded pretax, which can really boost the incentive to save. Traditional individual retirement accounts (IRAs) offer similar tax breaks upfront—you can deduct money you contribute (up to certain limits) when you file your taxes. Either way, you’ll owe income tax on earnings when you withdraw from the account, presumably in retirement, when you may be in a lower tax bracket.
- … Or tax breaks tomorrow. With a Roth workplace account (or IRA), you contribute money that’s already been taxed. The benefit: You won’t owe any tax on earnings when you withdraw as long as you meet certain criteria. That can be a big plus in retirement—especially if your tax bracket is higher when you withdraw than when you contribute.
- Put away a little at a time: You don’t have to fund your entire nest egg all at once. The task is much more manageable when you work on it over many years. However, the more you save, the faster you’ll reach your goal. If you’re under age 50, you can contribute up to $23,500 to your workplace retirement account in 2025. IRAs have an annual contribution limit of $7,000 for 2025 ($8,000 if you’ll be 50+ by year end). While it may be tough to put away that much, try to increase your contribution every year—perhaps after you receive a raise. That way, you won’t even have a chance to spend the money before it gets set aside for retirement.
Even if you’re older—between ages 60 and 63—you’ll have a major opportunity to save more in 2025. Under the SECURE 2.0 Act of 2022, you’ll be able to put away up to an extra $10,000 or 50% above the regular contribution limit (whichever is higher) per year.
How should you invest for retirement?
How you invest will depend on your level of risk tolerance. Generally, the higher the potential for gains, the more risk an investment involves. How do you feel about risk? Will you be able to ride out periodic and inevitable investing declines, or will you want to duck for cover?
If you can stomach a lot of risk, your portfolio can be more aggressive. Although past performance doesn’t guarantee future results, growth-oriented, stock-focused portfolios have been shown to produce higher returns over the long term and could be suitable if you have a high risk tolerance and a long time before you plan to retire. (Bonus: A longer “time horizon” can give you more time to recover from potential short-term losses.)
How does compound interest help you save for retirement?
Compound interest gives your retirement savings a boost. The more time your money has to compound and grow, the more opportunity for those earnings to earn additional money. This means that if you start early, you don’t have to set aside as much money as you would starting later.
Here’s a hypothetical example that drives home the point that the more time you have, the less you have to put away each month to reach your goals:
Emily is 25. By saving $440 a month, her nest egg will top $1 million by the time she’s 67, assuming a 6% average annual return on her investments.
Her 25-year-old friend Elliot, on the other hand, decides to wait five years before investing. He’ll need to put aside $613 a month, assuming a 7% annual rate of return to have the same portfolio at age 67. In the end, Emily will have paid $50,412 less for her $1 million nest egg.
Just five short years can make a big difference. That’s quite an incentive to start saving at as young an age as possible, isn’t it?
Prudential’s editorial team provides readers with valuable information on personal finances, retirement saving, and planning for the unexpected.
The compounding concept in these examples is not intended to represent performance of any specific investment, which may fluctuate. No taxes are considered in the calculations; generally, withdrawals are taxable at ordinary rates. You can lose money by investing in securities.
This does not constitute tax advice. Please consult an independent tax advisor.
Disclosure
Estimated amounts shown in "A Lesson in Returns" social video were calculated using a standard annual compounding interest rate equation of 9.4% annually. Actual results may vary. You should carefully consider a variety of options when determining how much money you will need to save for your retirement. If you need investment advice, please consult with a qualified professional. It is possible to lose money when investing.
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