According to conventional wisdom, workers should start saving as early as possible to capture the biggest benefits of compound interest. But reinvesting earnings earlier in life to grow savings is not feasible for millions of Americans facing rising living costs, stagnant wages, or other economic challenges. Is compounding interest for retirees and savings latecomers a viable option for creating financial security after their working years are past?
The answer, though nuanced, may surprise you.
Compounding Interest for Late Savers
The consensus on compounding interest still holds for late savers, contends Michael Hammelburger, a certified financial advisor and CEO of Bottom Line Group, a business consultancy firm in Baltimore.
“While it is true that starting savings early allows compounding to work its magic for a longer period, this does not mean that people who start saving later in life cannot benefit from it,” he said. “Every year of compounding can still help them grow their savings. The key is to begin as soon as possible and to contribute consistently.”
He recommends the following steps for late savers to maximize savings.
- Increase savings contributions to compensate for the shorter time horizon.
- Set up automatic transfers to savings accounts to ensure consistent contributions.
- Find ways to reduce unnecessary spending and other expenses, redirecting those funds to savings.
- Consult with a financial advisor to develop a customized savings and investment plan based on your specific goals and circumstances.
“Even if a person begins saving later in life, the compounding effect can increase their savings over time,” Hammelburger said.
Maximizing Contribution Benefits
Late savers can take advantage of certain 401k and IRA contribution benefits, according to Thomas Maluck, a National Financial Educators Council-certified instructor in Columbia, South Carolina.
Workers 50 and older can contribute $7,500 more to their 401k annually and $1,000 more to their IRA.
Beginning in 2025, another contribution incentive will kick in for workers aged 60 to 63. This cohort can contribute an additional $10,0000 annually, or 50% more than the maximum allowed at age 50 or older, whichever is larger.
“Considering IRA contributions must come from earned income, these rules represent a greater opportunity for the nearly retired to secure their nest egg in tax-advantaged accounts,” Maluck said.
Health Savings Accounts (HSAs) are another investment option that allows eligible employees to contribute, grow, and draw from their investments tax-free.
Before age 65, money can only be withdrawn for qualified medical expenses, or it’s taxed and penalized. But after 65, withdrawals for any purpose are tax-free.
“All of us are aging and will eventually face certain medical issues,” Maluck added. “An HSA could be an ideal shelter for long-term compounding, depending on individual health factors and investment options.”
Investment Strategies and Other Tips
Implementing investment options with a higher rate of return, such as low-cost index funds or diversified portfolios, can boost savings for those with shorter time horizons, according to Kenneth Garcia, a former financial advisor.
Dividend-paying stocks or bonds or real estate can also generate a steady stream of income while benefiting from compounding interest, he added.
“Additionally, retirement-focused investment options like target-date funds or annuities can provide a systematic approach to capitalizing on compound interest,” said Lauren Mendoza, a certified public accountant in Los Angeles and founder of business loan marketplace Bank Standard. “Late savers should also consider diversifying their income sources, exploring potential part-time work or freelance opportunities, and optimizing their Social Security benefits.”
Ryan Maxwell, CEO of Chicago-based equities data provider FirstRate Data, recommends minimizing debt.
“Paying off high-interest debts can free up additional funds for retirement savings,” he said.
Words of Warning
Those starting to save later in life should temper expectations, though, cautions Tyler Seeger, managing director of Retirement Being, an online resource for senior living communities.
“The crucial factor is understanding that the growth might not be as exponential as it would be for someone who started saving earlier,” he said.
Another problem with relying on compound interest is that your money will not grow much beyond inflation, warns Gordon Achtermann, a certified financial planner and principal at Your Best Path Financial Planning in Fairfax, Virginia.
He recommends using interest-bearing accounts to boost compound interest, especially if you’re dipping into your nest egg early.
“The main principle to keep in mind is that everyone should align their investments with their time horizon,” Achtermann said. Jason Co, the owner of the investment advisory firm Co Planning Group in Missouri, recommends avoiding high-risk ventures to compensate for the late start to saving.
However, it’s important to note that relying on compound interest and investment gains alone isn’t a holistic approach, he suggests. “Late savers should couple these strategies with disciplined spending habits and aggressive saving to ensure a secure and comfortable retirement.”
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.
