Some high-yield savings accounts are currently paying around 4.00% or 5.00%, but this is an unusually high rate. That’s due to current economic conditions as the Federal Reserve has repeatedly raised rates to fight inflation caused by COVID-19. In general, most savings accounts in recent years have paid under 2.00%, and many still do.
Because savings accounts typically don’t provide a very generous return on investment, it’s really difficult to get rich just by sticking your money in savings. But there are some steps you can take to become wealthy — and you need to follow them if you want to retire in comfort without trying to live on Social Security benefits that replace just 40% of pre-retirement income, according to the Social Security Administration.
Open a tax-advantaged investment account
The first step to getting rich is to take advantage of tax breaks that help you grow your wealth. Specifically, there are several tax-advantaged retirement plans you may want to invest in, including:
- A workplace 401(k): Your employer may offer this account, and you may be able to earn matching contributions. When you invest, you don’t pay taxes on the money you put into your account, so each contribution doesn’t reduce taxable income by as much.
- An IRA: You can open this account with any brokerage firm. You also get to take a tax deduction for your contributions. You don’t need an employer to help, and you’ll have a choice of which financial institution to invest with. You’ll also get to buy just about any assets available with your broker, and will therefore have a broad choice of investments.
You may also opt to open a Roth 401(k) (if your employer offers one) or Roth IRA (with a brokerage firm of your choice) instead. These accounts defer your tax savings until later. You don’t deduct contributions when you make them — but you withdraw money as a retiree without owing any taxes.
These tax-advantaged accounts can mean your money goes a lot further when you invest due to the tax savings — especially if you are also getting a matching contribution from an employer. The table below shows how a contribution might work for a 401(k) if you invest $5,000, get a 50% match from your employer on that entire amount, and are in the 22% tax bracket.
| Amount you contribute to your 401(k) | $5,000 |
|---|---|
| Tax break you earn | Up to $1,100 |
| Employer matching contribution | $2,500 |
| Amount you end up investing in your 401(k) | $7,500 |
| Amount you actually reduce your take-home income by after accounting for the tax break | $3,900 |
Data source: Author’s calculations
As you can see, there is no reason not to take advantage of tax savings because it’ll mean you don’t reduce your buying power by nearly as much as the total amount you’re investing.
The specific amount you end up saving over your career will depend on how much you invest, as well as what rate the deducted income would otherwise have been taxed at. But if you contributed $5,000 each year to your 401(k) for 20 years and all the money you contributed otherwise would have been taxed at the 22% rate, you’d save a grand total of $22,000 in taxes due to your investments.
Invest your money
Once you’ve opened your 401(k) or IRA, the next step is to pick investments. For many people, the best choice is an index fund.
Index fund investing does not require you to have any specialized investment knowledge. Funds track financial indexes and are designed to mimic the performance of those indexes. For example, you could buy an S&P 500 index fund, which is designed to track the performance of the S&P 500. You would gain an ownership interest in around 500 of the largest U.S. companies if you went this route.
Index funds provide easy diversification because money is invested in lots of different companies that are part of the financial index. They often charge low fees and have a consistent performance track record. The S&P 500 specifically has consistently earned 10% average annual returns over many decades.
That return on investment is enough to help you build wealth much more easily than putting your money in savings. In fact, $7,500 a year invested for 20 years at a 10% average annual interest rate would give you a $472,518.75 nest egg — compared with just the $232,269.00 you’d have if you had the money in a savings account earning 4.00%. It’s also important to note that savings account APYs fluctuate, so even if you’re earning 4.00% now, you likely won’t be over a long period of time.
By taking advantage of tax breaks and investing for your future, you can get rich and enjoy a life of future financial security instead of one filled with money worries.
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