Get In Your Company s 401k/Retirement Plan As Soon As Possible Eric C. Dyson Gallagher Retirement Services No matter if you re 22 and just starting your career or 52 years old and nearing retirement, you should start investing in your company s retirement plan as soon as possible. Why?... Because compound interest is the 8 th wonder of the world. The more time you have to let it work for you the more wonderful it becomes to you. There are different versions of employer sponsored defined contribution plans. Some companies offer employees a 403b, 457 plan, SIMPLE IRA or similar benefit. They are similar to a 401k. I will refer to all workplace defined contribution plans as 401k s. Companies leave it up to you, the individual, to take some action with these types of plans. Without doubt, acting early gives you a better chance of seeing long term success. Example: (Ignoring any employer contributions to the plan) Tina and Mark, both 22 years old start similar jobs offering essentially equal 401k plans. Assuming they invest a constant amount each month and select equal investment choices over a 40 year career. Let s also assume that the net rate of return for both Tina and Mark amounts to an 8% annual return that is compounded monthly. Tina carefully constructs a budget and decides to begin investing approximately $250 per month of her gross pay in her company s 401k plan. Mark, decides he will make up for saving and investing once he starts a family and settles down. Mark s entertainment budget easily runs $250 a month and he seems to think it is a much better use of his money. Mark obviously hasn t seen the bills and the budget that invariably accompany a spouse and two children. My extensive research has shown that WITHOUT EXCEPTION 100% of all married parents were at one time in their life single and naïve to both the emotional and financial challenges of being a parent. Imagine that! Ten years later Tina, age 32, decides to be a stay at home parent. Although no longer working, she leaves the accumulated money in her 401k to continue to
grow. In our hypothetical example, after only 10 years, her contributions and earnings would be worth just over $46,000. Before we continue let s put some of these numbers into perspective. How many 32 year olds do you know that have $46,000 in their 401k plan? How many have a net worth of $46,000? I m sure that there are a handful that do, but not many. You might want to debate the fact that most 22 year olds can t afford to put $250 per month in a 401k plan. If a 22 year old wants to find $250 per month in his or her budget to invest into a 401k plan and can find the right reasons to do so then it can surely happen. You might want to argue that $125 per month is more reasonable and affordable than $250. Not only is $250 a reasonable figure to assume but it is a 10% contribution rate for someone who earns $30,000 a year. Most studies on accumulating wealth from your own paycheck recommend setting aside 10% of your pay. Had Tina started with $125 a month then she would still have over $23,000 in her 401k plan at age 32. How many 32 year old workers have over $23,000 in their 401k plan? In order to keep things simple, remember this illustration assumes there are no increases in the contribution amounts respectively over an entire lifetime. However, current 401k contribution guidelines allow workers over age 50 to put away more than $20,000 a year from their own paycheck. That means there are people in America contributing over $1500 per month to their 401k plans. The dollar amount that you start with is not as important as getting started. The most important part is to just get started. The magic of compound interest works regardless of how much money you start investing. The only catch is it has to be an amount greater than zero. Now back to our story Tina left her money to grow in the same hypothetical investment that earns 8% per year. By not touching her account and simply letting it grow, by age 62 it would be worth just over $500,000. This illustrates where compound interest really is the 8 th wonder of the world. $250 a month for 10 years (age 22) = $30,000 in contributions After 30 more years of compound growth = $500,000 at age 62
Now back to Mark... Mark starts investing $250 per month at age 32 and continues for the next 30 years resulting in total contributions of $90,000. Although Mark actually contributes three times as much as Tina, the results are not as attractive. First 10 years, no contributio ns $250 a month for 30 years (starting at age 32) = $90,000 in contributions = $372,620 at age 62 How can this be? Tina allowed compound interest to work for her ten years longer than Mark did. How much did this cost Mark? Let s assume that Mark had started at the same time as Tina and just continued to invest until age 62. In other words, lets present a third scenario of a 22 year old who starts investing $250 per month at age 22 and continue to invest $250 per month until age 62. Had this been Mark, his total account balance would be $872,853. Not a bad start at a retirement nest egg. But the price for waiting was 10 years is approximately $500,000. Hypothetical Growth of $250 per month at 8% Annual Return $1,000,000 Mark's Balance Tina's Balance Balance if invested age 22 through age 62 $900,000 $872,853 $800,000 $700,000 Value $600,000 $500,000 $500,233 $400,000 $372,620 $372,620 $300,000 $200,000 $100,000 $- $225,358 $147,262 $147,262 $101,525 $45,738 $45,738 $45,738 $- $250 $250 $- 22 32 42 52 62 Age
Mark waited 10 years, or 3650 days. Therefore the cost per day to wait was approximately $137 per day. There are so many reasons or excuses to delay your personal retirement planning. Some of them sound like this: No one works for the same company for 40 years anymore. Who can invest every month for 40 years without having a financial emergency? I m going through a divorce! Do you know how much college costs these days? I m lucky that I can make my car payment. I don t know anything about the 401k at work. I have no idea where to invest my money. Your example is for a 22 year old and I am 52! It s too late for me. If I take money out of my 401k before I retire I have to pay taxes and penalties. First, let me say that I can personally identify with almost all of the items on the list. This is real life and not just words. There are so many excuses and they will continue throughout your lifetime regardless of age. However, ask yourself if these excuses are worth the risk of reaching retirement age broke. Priorities must be placed on saving and saving early. You are responsible for your own fate at retirement. You must make the decision to plan for it. There is only one way to begin putting compound interest to work for you. Get started regardless if the amount is small. If you have not been exercising and you are in poor shape, a health professional would not recommend that you start your exercise program with a 5 mile jog. They would recommend starting slow and building up to that 5-mile jog The same is true with your finances. Don t try to start with too much. Start in manageable amounts and slowly work your way to bigger and better things. For every excuse there is a more compelling reason to get started. Excuse: I m not sure what to invest in. Answer: Start putting money away. You can always change your investments. 401k plans have a default investment option that is usually considered an appropriate, default investment selection. In fact one of the provisions of the Pension Protection Act of 2006 mandates that Plan Sponsors, AKA Your Employer, select a default investment option that is appropriate for an employee that has money going into the retirement plan but makes no choice on where to invest the money. The reasons to get started are
there. The answer to almost every challenge is out there. Seek and you will find. What if you don t have a 401k (or other retirement plan) at work? Then establish an Individual Retirement Account or open another type of savings vehicle to prepare yourself for retirement. Take the same approach. Start with what is affordable and increase the amount that you contribute in manageable amounts. One of the most common questions I hear is, Can I open an IRA if I am in the 401k at work? You can open an Individual Retirement Account (IRA) whether or not you have a workplace retirement plan. There are rules surrounding the type of IRA you may contribute to as well as minimum income and age requirements for IRA s. However participating in a 401k plan at work does NOT preclude you from contributing to an IRA. The message is clear; compound interest is the easiest way to build your retirement fund. You are in the driver s seat let it get started working for you today! Can you afford to lose $137 a day? If not then you had better get started.