When Should I Start Saving for Retirement?
Saving money for retirement is easy and the earlier you start the easier it is. This might sound like common sense to you but the importance of starting early may not be entirely clear to you. Planning for retirement is really easy to put off when you are in your 20s but these are the years that solidify how enjoyable your retirement will be. Most of the time when charts and graphs are posted in blogs you just read over them so I am going to save you from that and give you an example of a person making a moderate income for his career and how two different starting periods can make such a big difference in the amount of his 401(k) at retirement.
For our first example we have 24 year old banker who has worked for exactly one year since graduating college.
Banker works an entry level job for a national bank in his hometown. He makes $40,000 a year and receives a 4% salary increase every year. He currently rents an apartment that costs him $950/month or $11,400 a year. His employer has a great 401(k) plan that matches 100% of his contribution up to 5% and he contributes 25% of his salary which is $10,000. This leaves taxable income at $30,000. Let's assume he pays 25% to federal, state and local taxes. After yearly rent cost banker is left with $11,110 or $925 a month for all other bills. This is not a lot of money but gives him something to work towards increasing.
If Banker wants to retire in 40 years at age 64 and his average salary for his career is $65,000, assuming a modest 6% annual rate of return (ARR) on portfolio his 401(k) balance will be $3,217,923.
If Banker retired 5 years later at the age of 69 his 401(k) would increase to $4,419,771.
The second example will be the same Banker but instead of starting to save for retirement at 23 he starts at 30 and is not really as interested in contributing to his 401(k).
This banker know he needs to start contributing to his 401(k) so at age 30 he talks to some friends and they recommend he contribute 10% of his income. With his 5% match from his employer he will be contributing 15% of his annual salary which we are averaging to be $65,000. This will be 9750 a year which he feels is pretty good.
However, at age 64 when he plans to retire his 401(k) balance will only be $1,121,021. After withdrawing and paying taxes he will have around $800,000 to last him the rest of his life. That is only $40,000 a year and if we assume a 2.5% rate of inflation over the next 40 years that same $40,000 will only have the purchasing power of ~$15,000.
Now hopefully over the next 40 years Banker will be able to build some other assets such as a house and it is possible social security will still be paying retires (unlikely) but if his plan was to use his 401(k) for retirement he is going to have a tough time.
There are other options!
Hopefully your 401(k) is not the only way you plan on preserving wealth for your future. I will discuss different options that are available and my experience and progress in later blog post. Subscribe to email alerts below so you can get updates when I post new blogs.