How to build your retirement savings with compounding interest

Long ago, some people stashed away their savings in mattresses or cookie jars. This may not be a good idea if you have an emergency such as a flood or fire, or even a lapse in memory!

Fortunately, you now have many choices for storing your money—in reliable retirement accounts. These choices may provide stability and security, as well as the important bonus of earning interest and compounding the value of your money. This means increasing the value of your retirement savings well beyond the amount you have deposited.

How compound interest works

When you have money in an account with compound interest, it allows you to build upon your savings quickly because you earn interest on the amount you have contributed in addition to the interest you have earned in prior periods. Within each period, you’re earning interest on the total balance in your account, not just on what you have managed to save.

These points add up to an important lesson: Saving early as early as possible can be critical to meeting your retirement goals. Saving early can also help reduce the need for you to contribute larger sums to your savings as you near retirement.

As an example, if you put $1,000 into an account with simple interest of 3.00% Annual Percentage Yield (APY), you will have approximately $1,900 after 30 years. If, however, you have that same $1,000 in an account with compound interest of 3.00% APY, with a daily compound frequency, you will have approximately $2,460 after 30 years.

Now let’s talk about how to save for retirement.

Choices for retirement accounts

Once you start saving for retirement, you have several choices of retirement accounts: 401(k), Roth IRAs, or Traditional IRAs.

• 401(k). Many companies offer 401(k) savings opportunities for employees. With a 401(k) you have money withheld from your paycheck for a retirement account managed by the company’s financial partner. Your contributions may be withheld pre-tax, lowering the amount of taxable income in your paycheck and maximizing the amount you contribute to your retirement account. Also, it is common for companies to match a percentage of your total contribution.
• Roth vs. Traditional IRA. The Traditional IRA is funded with pre-tax funds, meaning that you don’t pay tax on the money that you put into this account now, but you will pay tax on it when you withdraw the funds from your account later. The Roth IRA is taxed up-front, so you don’t get a tax savings on your deposit now, but you won’t pay taxes on qualified distributions in retirement. Check with your financial or tax advisor for help making the best choice for your personal needs.

Whichever path you choose, try to set up regular salary contributions with a fixed amount from every paycheck going into your retirement account. The IRS has a limit on annual contributions based on age and marital status, so check to see what applies to your personal and family situation to avoid overestimating the amount you can contribute.

IRA interest rates/APY

Because retirement accounts are established to meet long-term savings goals, banks and other financial institutions typically consider retirement accounts to be less risky than other consumer deposit account types, such as savings and money market accounts. What that means for you is that banks may offer slightly higher IRA interest rates than regular savings accounts rates. This is another way that retirement accounts make your savings grow faster.

Most financial institutions will give you current information on IRA interest rates or APY. They can’t predict the future, but with a fixed-rate IRA CD, you know exactly what interest rate your money will earn over the term you select. Like other consumer savings accounts, IRA deposits are protected by FDIC insurance up to $250,000 per depositor, per insured bank, per account ownership category. This makes them far more secure than the money in your mattress.

The article and information provided herein are for informational purposes only and are not intended as a substitute for professional advice. Please consult your tax advisor with respect to information contained in this article and how it relates to you.

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