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  • Perplex

    Financial Mathematics (Lesson 3/3)

    Annuities

    1 / 10

    Discussion

    Taylor is 25 years old and opens a workplace retirement plan. She decides to put away some money into it every month until she turns 65, the age she will retire. The account earns about 7% interest annually.


    The retirement plan will pay her a fixed amount every month after her retirement until her 95th birthday.

    (a)

    Why should Taylor do this instead of just keeping her cash in a checking account?

    Solution:

    A regular checking account pays almost no interest (often well below 1% per year), so any money you leave there barely grows and in fact loses value due to inflation.


    In contrast, Taylor’s retirement plan grows at about 7% each year, so her contributions add up and compound over 40 years to create a much larger fund.


    Keeping cash in her checking account would leave her with considerably less at age 65 that she would be able to withdraw over the next few decades.