Start Saving Today For Tomorrow
My401k is growing. Yes, even in this economy, I consider my 401k account to be growing regardless of the unrealized profit and loss profile for the year. Why do I feel this way about my401k? It’s simple, I, like many of you, work for a company that provides matched contributions up to 5%. So whether the market is bullish or bearish, I make sure that my contributions come in at an absolute minimum of 5% of gross income. It would be foolish not to, I’m sure you can see why. But even so, the number of people who forgo this “free money” is staggering. In this article we will present the power of compounding interest and how it relates to my401k and yours.
Let’s start off with some basic information on the 401k itself. Does it mean you will have a $400,000 the day you retire to spend on boats and vacations? Not quite. Actually, let’s aim to have twice that much, whattya say? The name actually comes from subsection 401(k) of the Internal Revenue Code. A person can make contributions, pre-tax up to an annual limit. The limit changes every year so we will leave that out for now. 401(k) plans are considered “Defined Contribution” plans, different from Pension plans which are considered “Defined Benefit” plans. Notice the operatory word, Contribution vs. Benefit. The burden for retirement planning has made a shift from the employer providing “benefits” to an employee providing “contributions.”
Due to careful planning my401k is on track, but according to the Wall Street Journal, “the median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement.” This is a frightening statistic. Clearly, the 401k system is failing. But is it the 401k plan that is failing its cohorts? Or the people responsible for its funding? I contend it’s the latter. Defined benefit pension plans of the past required no sacrifice on the part of the employee, and provided sustainable benefits through retirement on the company’s dime. The 401k on the other hand requires a conscious decision by employees to redirect income away from their paycheck and into an account that they can’t touch until they are 59 ½ years old. We are shortsighted, and poor in retirement. Bad combination.
So what do I recommend that you do? If you haven’t started, start now. Save early and often, and let the wonder of compound interest work in your favor. Let’s take a look at what your retirement benefits would look like if you started at a salary of $40,000 at age 22 and saved 5% of your salary with a 5% company match, and an expected annual salary increase on average of 5%. Also, we will assume a modest 7% return on invested capital. If you do this, (5% of your salary is not life changing money) you will have just under $800,000 in your 401k at the time of your retirement. Now what would happen if you were to put 10% in instead of 5%? Your retirement balance jumps to over $1.8 million. Sounds pretty good huh? But you have to plan. You can’t hit a target that doesn’t exist, so make a plan and aim high. If you fall short, you will still be able to live out you golden years without having to beg borrow and steal from your kids.