When it comes to saving for retirement, the earlier you can start, the better. Although you can still reach your retirement savings goal if you start later in life, it will cost you much more in terms of contributions than if you start early. But beyond the increased amount of savings you’ll have to sock away, there are plenty of other consequences of waiting to start a retirement plan. Here’s a look at some of the repercussions that come with delaying retirement plan contributions by even a single year.
You’ll Have To Contribute More To Meet Your Goals
Although saving any amount of money is a good thing, the main reason you want to start contributing to a retirement plan early is to take advantage of compound interest. The more time you can give yourself to enjoy the power of compounding, the better off you’ll be when it’s time to start drawing from your retirement account. The effect of compounding is more dramatic over a longer time period, but even a single year of deferring retirement contributions is enough to have an impact. Here’s an example to illustrate, using the following suppositions:
- Retiring at age 65
- Beginning contributions at age 21
- Earning an 8% annual return
- Contributing $5,000 per year
Under this scenario, you’ll be sitting on a nest egg of about $2.02 million. But if you wait to contribute just a single year, when you are age 22, your retirement account balance will only hit $1.86 million. While it’s true that in either case you’ve done a good job of saving and investing, waiting just a single year has ended up costing you about $160,000, or nearly 8% of your entire balance.
You Might Get In the Habit of Not Saving
Saving is hard to do. The longer you put off making regular contributions to your retirement account, the more you’ll have to fight against the inertia of not contributing. This is why many financial advisors counsel clients to “pay yourself first.” What this means is that you should set aside a portion of your paycheck for your savings before you live off what’s left. This is in direct contradiction to what many people do with their paycheck, which is to spend all of it first and then contribute to savings with whatever is left. It’s extremely hard in that scenario to end up with any money “left over” at the end of the month, as it usually finds itself going toward both needs and wants. Every year that you defer making contributions to your retirement account can make it that much harder for you to ever start.
You’ll Pay Higher Taxes
To be clear, you don’t owe additional tax for not contributing to a retirement plan. However, you won’t get the benefits of the tax deduction that you’re typically entitled to when you contribute to a retirement plan like a 401(k) or IRA. For example, if you’re in the 37% tax bracket, a $10,000 contribution to a pretax retirement plan saves you $3,700 in taxes. Looking at it another way, you’re getting credit for $10,000 in contributions in your retirement plan but it’s only costing you $6,300 out-of-pocket, which is an amazing deal. If you delay contributing to your retirement plan, you’ll also be passing up this “free” money in the form of a tax break. In this scenario, that would amount to $3,700 per year, or $37,000 if you delay contributing for 10 years.
You’ll Miss Out on Free Money
Another way you’ll miss out on “free” money by delaying retirement plan contributions comes in the form of the employer match. Although employers are not required to match employee retirement plan contributions, in practice, most large companies do. Imagine you work for an employer that matches 100% of your contributions, up to 5% of your salary. If you make $50,000 in a year and contribute $2,500 to your retirement plan, your employer will kick in another $2,500, effectively doubling your contribution. In that scenario, that’s a 100% return on your investment before you even begin investing. Every year you delay getting a retirement plan, you’re missing out on this great source of additional retirement funds, which can amount to a significant portion of your entire retirement account balance by the time you’re ready to begin withdrawals.
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