So your company offers a retirement plan for its employees. That’s fantastic! But why should YOU put money away into it? You’ve probably heard both good and bad things about your plan. In what follows I’ll answer a few of the objections to investing in your company sponsored retirement plan and 4 MAJOR reasons you should consider contributing:
There are several different company sponsored retirement plans (401k, 403b, SEP, SIMPLE, etc) and depending on your employer they may offer a company match. A common match on 401k plans would be 100% up to 3%, then 50% up to 5%. This means the company will match dollar for dollar on your first 3%, then 50 cents on the dollar up to your next 5%.
For example if you make $50,000 and you contribute 5% to your plan, then your employer would match you 100% on your first 3% (3%), then 50% on your next 2% (1%) for a total of 4% or $2,000 over the year. Let’s say you work for that employer or another employer with the same match for 20 years and are able to invest that money to get 8% return. Just counting your employer’s contributions you’d have a nice $91,523 from your employer.
Time Value of Money
There is no time like the present to begin saving. You’ve heard it from everyone and their dog that you don’t need to save a lot if you have time on your side. Some of you reading this are thinking, but Matt I don’t have a lot of time on my side. If that is you allow me to illustrate a savings period of 10 years and what that could mean for your savings plan.
Let’s use the same person making $50,000 a year. In this example you are able to save 15% to your retirement savings plan and your employer matches you 4%. You are able to get an 8% return on your investment over this period of time. At the end of this 10 year period you’d have a nice chunk of $137,622.34 for your retirement. Is this enough to retire on, probably not, but it gives you a nice starting point to supplement social security and pension money.
What about the younger person who has 30 years of accumulation? Well that person who saves 10% of their $50,000, their employer matches 4%, and they earn an 8% return would have $792,982 for them in 30 years. Now several of you read this and may think two things.
1. What if I can’t save 10% every year? I mean I’m going to have kids, I’ll need to buy things, and life will happen.
But what if you could save more than 10% in other years. My point in this isn’t that you need to make yourself poor on a monthly basis in order to accomplish your financial goals. My point is that by being diligent in a strategy you could accomplish your financial goals. Is there a cost to it? Absolutely, the cost is sacrifice today for your future needs.
2. Matt, you didn’t account for inflation.
This is correct and over this period of time it effectively cuts the purchasing power of this money in half using a 3% inflation assumption. Surely you’d agree with me that saving something is better than nothing. This also illustrates that maybe saving 10% isn’t enough. As a general rule of thumb I recommend saving 15% of your income towards retirement.
The difference between saving in your 401k and an individual/joint investment account is the tax advantage. There are two different options for this: pre-tax (traditional) or Roth. Not all plans offer Roth as an option. The difference lies simply in when you pay the taxes: pre-tax – pay the taxes when you take the money out, enjoy tax deferred growth, Roth – pay the tax when you put the money in, enjoy tax free growth.
Pre-tax isn’t necessarily better than Roth and Roth isn’t necessarily better than pre-tax. The answer to what is best for you is multi-faceted. If you believe that income taxes will only rise in the future, then you might be best served using Roth as you’ll pay the taxes today at the lower tax rate, then take distributions in the future tax free when taxes are higher.
If you believe income taxes will be lower or at least you’ll be in a lower tax bracket, then you might be best served using pre-tax as you’ll get a tax deduction in the year you make the contribution, then take distributions in the future at the lower tax bracket.
The IRS agrees to give you these tax advantages as long as you earmark the money for retirement (after age 59.5).
We are all creatures of habit and it is easier to not spend money if it never hits your bank account. This is the last reason you should enroll in your company sponsored retirement plan. Most of your plans likely allow you to simply enroll in payroll deduction meaning all you have to do is tell them how much you want to contribute to your plan, then it is deducted from your paycheck.
In conclusion the goal is to save for your future self. I have often heard that a contribution into your retirement plan is paying your 65 year old self. Consider these reasons among others as reasons you should save today.
And, as always, feel free to reach out to discuss your company sponsored retirement plan.