The phrase “perfect storm” has been used more recently than when the movie was out! Here in the United States, we’re being hit with rising costs, falling home prices, volatile stock prices, the subcrime (oops, make that subprime) mortgage crisis, and talk of a possible recession.
Recently, we discussed why cashing out a 401(k) is one of the worst things to do in response to these tough times.
Today, we want to discuss cutting back on contributions to a retirement plan. Two to three months ago, the word was that people weren’t reducing the investments they make for their golden years.
Even now, the overwhelming majority of people aren’t making any changes. However, there is evidence that more people are considering (or are) cutting back.
It’s certainly understandable – insurance, groceries, gas, taxes all keep going up. Investing less in a 401(k) is a way to put more dollars into a paycheck now.
3 reasons not to cut back on your 401(k)
#1 – Contributions are made with pre-tax dollars – Assume you’ve been contributing $1,000 a year to your 401(k). You stop making contributions so one would think that would mean $1,000 more in your paychecks over the course of the year. But you have to account for taxes – if you’re in the 30% tax bracket, you’ll owe $300 in taxes on this $1,000. So you’ll only net $700 by stopping your contributions.
#2 – Money accumulates tax-deferred – With your retirement plan, money is compounding on money on top of more money. And since you don’t pay any taxes on it until you take it out, all of your money keeps working for you, rather than paying a part of it every year in taxes (and therefore having less money to accumulate on top of).
#3 – Employer match – Employers match as much as 100%, up to some limit. So say, for example, you contribute 3% of your salary and your employer matches that. It’s like found money … your employer is guaranteeing you a 100% return on your initial investment.
Now granted, this is part of your overall compensation. However, we often look at our tax refunds as found money, when it is just a return of an overpayment. This is truly found money – the employer is giving you money as long as you invest up to the maximum. It’s your choice.
Cutting back could cost you $53,551
Consider a fictional 30-year old woman who has been investing 3% of her $50,000 salary, with her employer matching it 100%. Money is tight, so she decides that she will stop investing for three years. This $125 invested for just three years, and then left alone until she retired (at age 62) would have grown to $53,551, if she earned just 6% on her money.
So if she invested just 3% of her salary for the next 3 years, it would grow to 108% of her salary when she retires.
A small amount of money now makes a huge difference in the long term. So at least try to keep investing as much as your employer matches because you get a huge boost in your portfolio by hitting that target.
Until next time, here’s to your bigg success!
(Image by srbichara)