Personal Finance: The Importance of Starting Early

When You’re Young—In Your 20s

We’ve all heard the famous quote by Albert Einstein, the one where he said, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” And it’s true. In many cases, if you start out early—perhaps in your teens or 20s—saving just a small amount each month, you can amass more money through time than if you start saving at a later age, even if you save a larger amount each month. Of course, it depends on what you invest in. Be sure to check with a trusted financial advisor about how this works.

Investopedia uses this example:

Let’s say you start investing in the market at $100 a month, and you average a positive return of 1% a month or 12% a year, compounded monthly over 40 years. Your friend, who is the same age, doesn’t begin investing until 30 years later, and invests $1,000 a month for 10 years, also averaging 1% a month or 12% a year, compounded monthly.

Who will have more money saved up in the end? Your friend will have saved up around $230,000. Your retirement account will be a little over $1.17 million. Even though your friend was investing over 10 times as much as you toward the end, the power of compound interest makes your portfolio significantly bigger.

When You’re Older—In Your 40s, 50s or Early 60s

As you head into retirement, starting early to map and plan out your retirement—well before you retire—can help you for many reasons, because there are a lot of moving pieces to consider. Plus, everyone’s situation is completely different and what might work for someone else might not be right for you at all. For instance, one person’s desired retirement lifestyle could be drastically different than another person’s, requiring different budget amounts. (Consider whether you want to stay home and become a painter, or travel the world with your entire extended family. That’s what we mean by drastically different budgets.)

Once you have your required retirement budget amount settled, timing then becomes very important. A financial advisor with a special focus on retirement can really make the difference by laying out a retirement roadmap just for you. Here are some of the things you should know and think about:

1) Medicare Filing – Age 65

You are required to file for Medicare health insurance by age 65 or pay a penalty for life. To avoid this penalty, be sure to sign up for Medicare within the period three months before and three months after the month you turn age 65. If you are still working or otherwise qualify for a special enrollment period, you can sign up for Part A which is free for most people, and then sign up for Part B after you retire. Visit https://www.medicare.gov/basics/costs/medicare-costs/avoid-penalties to learn more about penalties and how you can avoid them.

You are required to have Medicare coverage if you are not working or covered by a spouse with a qualified health insurance plan, and Medicare (other than Part A) is not free. In fact, it costs more if your income is higher. Your Medicare premium is often deducted right out of your Social Security check, and premiums generally go up every year.

When you sign up for Original Medicare Part B or a replacement Medicare Advantage plan, you pay a monthly premium that varies depending on your income. There is a standard base premium that most people pay, but individuals and couples with higher incomes typically pay higher premiums based on their modified adjusted gross income (MAGI) from two years prior. For couples filing jointly, the highest premiums are charged to those with the highest income brackets.

Medicare premiums and income thresholds are subject to change each year, so it’s important to review the current rates annually or consult official Medicare resources for the latest information.

If you plan ahead, your advisor might help you plan to take a smaller income in the years prior to turning age 65 in order to keep your Medicare premium smaller. For instance, some people might want to retire at age 62 or 63 and live on taxable income withdrawn from their traditional 401(k) or IRA account/s before they even file for Medicare or Social Security. Each person’s situation is completely unique, but advance retirement planning may help you come out ahead in the long run.

2) Social Security Filing – Age 62, 66-67, 70 or sometime in between

Another moving piece in the retirement puzzle is Social Security. The youngest age you can file for Social Security is age 62, but a mistake some people can make is thinking that their benefit will automatically go up later when they reach their full retirement age—between age 66 to 67 depending on their month and year of birth. This is not the case. If you file early, that’s your permanently reduced benefit amount, other than small annual COLAs (cost of living adjustments) you might or might not receive based on that year’s inflation numbers.

Filing for Social Security benefits as early as age 62 can reduce your monthly benefit by up to about 30%. Conversely, delaying benefits beyond your full retirement age up to age 70 can increase your benefit by roughly 8% per year. After age 70, no further increases apply.

Planning ahead for when and how you file for Social Security can significantly impact the total benefits you receive over your lifetime. Additionally, married couples, widows or widowers, and divorced individuals who were married for at least 10 years have a variety of filing options that can help optimize their retirement income.

3) Taxes In Retirement

Thinking that your taxes will automatically be lower in retirement may not be true for everyone. It’s important to explore early planning strategies to potentially mitigate taxes. Remember, money saved in traditional retirement accounts like 401(k)s is generally subject to income taxes when withdrawn, and even Social Security benefits can be taxable—sometimes up to 85%—depending on your combined income.

Additionally, the IRS requires annual minimum withdrawals from certain retirement accounts starting at a specified age, with strict rules about timing and amounts. Failing to take these required minimum distributions (RMDs) on time can result in significant penalties, on top of the income taxes owed.

Planning ahead to do Roth conversions—transferring money from taxable or tax-deferred accounts into tax-free Roth accounts—may help reduce taxes over the long term. However, Roth conversions must be done carefully as they are permanent and irreversible.