Along with saving for your short term goals and tucking some money aside for a rainy day, it’s also important to implement long term savings.
Long term savings are typically used for funding your retirement or your children’s college expenses. Establishing a plan for long term savings can seem like a daunting task at first, but it’s one that you can accomplish if you put your mind to it. The great news is that, with long term savings, you can benefit drastically from the interest build-up.
Just as with short term saving, there are important things to consider in your long term savings plans. For example, the longer you have for saving up, the less money you need to allocate each month toward your goal.
The Power of Compound Interest
Let’s look at an example of the effect of interest over the long term. If you start a retirement plan when you’re 25, and put in $100 per month for 40 years, here are your results at an 8% interest rate:
- Total amount saved: $353,855.46
- Total Principle: $48,000 ($100/month for 40 years)
- Total Interest Earned: $305,855.46
Compare the two figures above. It shows show you the power of compound interest. Over $305,000 of your savings is from interest alone! As your savings grow, you’re getting paid interest on the interest you already received.
So it’s in your best interest to take advantage of all the interest you can and start as early as possible on your long term savings.
Saving for College
With the price of tuition skyrocketing at unimaginable rates, it’s very important that you have a plan to prepare for these costs.
Here are some strategies that can help you build a hefty college fund:
- Start early. It’s best to start a college fund in your child’s first year, as that will give you as much time as possible to save the necessary funds. You can set up an account in their name, set up a savings bond, or simply open an account in your name and allocate it as a college fund.
- Assemble a team. Try to get other relatives involved. Most aunts, uncles, and grandparents are happy to contribute to a child’s education. It doesn’t need to be a drastic amount, but every little bit helps.
- Instill a good savings mentality in your child and let him put in his little piece into the pie. Regular contributions from your child, even if it’s only a dollar, teach him the importance of saving, and this value will benefit him the rest of his life! It also increases the college fund. When he’s ready to use it, he’ll feel pride in knowing that he helped build it.
- Seek security plus a higher interest rate. Browse around and find which bank has the highest interest rate. Online banks tend to have higher interest rates for savings accounts, but do your research and see which one pays the best rates.
- As you deposit more money and the balance grows, so too will the amount that the bank will pay you in interest. A difference of even 1% can have a big effect on your total savings.
- Many investment products pay more interest than a savings account at your bank. Look into using mutual funds, exchange-traded funds, and other investments to increase your rate of return. However, as the interest rate grows, so does the risk. A college fund may not span enough years to tolerate much risk. So keep safety in mind as you search for higher returns.
Student Loans and Government Aid
Even with savings in a college fund, there’s a good chance that you or your child will need to take out some form of student loan to help pay the bill, especially if they attend an out-of-state college or pursue post-graduate degrees.
You can apply for a loan through your local bank, but the federal government also offers financial aid should you need it. Federal student loans generally charge lower interest, so it may save you some money to look into it.
In addition, unlike most loans, federal student loans don’t activate immediately. Depending on the terms of the loan, you can usually delay the start of payments until after your child graduates. This allows the student to focus on his or her schoolwork. After that, there’s often a “grace period” of a few months before the bills start rolling in.
For more information on government based student aid, you can go to:
http://studentaid.ed.gov/PORTALSWebApp/students/english/index.jsp
Scholarships
One of the best ways a student can save money on college is to get a scholarship. These can be offered on an academic or athletic basis. Some offer a completely paid-for education, while others cover only a portion of the fees. Of course, some is better than none. With the cost of education as high as it is, any assistance is beneficial.
A major benefit of scholarships, of course, is that you don’t have to pay them back!
When you do your research, you’ll discover that there are tons of scholarships available! If you’d like more information, visit your local bookstore or do some research on the internet.
Also, once your child has decided on a college, take advantage of the college’s financial aid office. This office gives you access to a multitude of scholarships available from the college’s alumni association, as well as a host of other sources.
Saving for Retirement
Retirement is the big kahuna when it comes to savings goals and it’s also the most important! The better you plan, the sooner you can reach your goals and retire free from financial stress.
While basic savings accounts may suit your needs for the most part, it’s recommended that you look into other investment services that can provide a better rate of return on your funds. There are 2 basic retirement accounts that are the preferred method for most working people, the 401(k) and the Individual Retirement Account (IRA).
IRA’s
IRA’s are retirement accounts that you can open with your bank. They allow you to create a portfolio of stocks, bonds, and mutual funds that will provide a much greater return than that of a simple savings account. There are two general types of IRA’s.
Traditional
The traditional IRA is the actual investment account. You can fund it with cash or cash equivalents, so while baseball cards and comic books can make great investments, you can’t fund an IRA with one.
One of the perks of the IRA is that the money you deposit isn’t taxed. Basically, when you siphon off some money into that account it’s considered “pre-tax” dollars. This allows you to legally keep some of your money away from Uncle Sam, at least for a while.
When you hit retirement and start taking the money out, that’s when they tax it and consider it your income.
If you’re going to deposit money into a traditional IRA, ensure that you don’t need that money at all. Taking money out of an IRA before you hit age 70 will incur penalties, plus you’ll have to pay income taxes on it as well.
Roth IRA’s
Roth IRA’s are different from the traditional in that these aren’t tax deductible. While the deposits are considered “after tax” dollars, it’s much easier to get to your money if you need it with far fewer penalties involved.
There’s a deposit limit of $5,000 per year into your Roth IRA account ($6,000 if you’re over age 50). If you have both a Roth and Traditional IRA, than that number applies to both accounts combined. The limit is still $5,000 or $6,000; it doesn’t double just because you have two accounts.
401(k)
Another option you have when it comes to retirement is the 401(k). Unlike IRA’s, where you sign up through your bank, a 401(k) is done through your employer. 401(k) accounts have an annual deposit limit of $16,500.
Much like an IRA, any contribution will not be taxed until you withdraw from it. Earnings made from the 401(k) are also tax deferred until the money is withdrawn. Also like an IRA, taking money out of your 401(k) before you reach the minimum age (60 in this case) will result in hefty fees and penalties.
One of the major perks of a 401(k) is that some employers match your deposits up to a certain percent. This will essentially put free money into your account and expand your nest egg quite significantly.
TFSA and RRSP in Canada
In Canada, you can get what’s called a Tax Free Savings Account (TFSA). You must be 18 in order to open a TFSA. You can withdraw money at any time without tax penalties. While the deposits aren’t tax deductible, money made from that account isn’t taxed.
Canadians also have what is called a Registered Retirement Savings Plan (RRSP). This is much closer to America’s Traditional IRA, only the deposit limit’s much higher than that of America’s. It also doubles as a 401(k) as employers can put money from your paycheck straight into the account.
Individual Savings Account in the United Kingdom
In the UK, you can get what is referred to as an Individual Savings Account. The ISA can be divided into two components: a cash component and then a stocks and shares component. It’s possible to transfer funds from the cash to the stocks component, but not the other way around.
