Max it out - don't get behind the 8 ball
Mar 14 '00
There's no or about it...401k (and/or IRA's) AND savings are both an important part of any retirement you might some day have.
But in saying that, there are two important statements I wish two make about 401k's:
1.) MAX out your company match
2.) ALWAYS max out your company match
This may seem redundant, but it's not. Let's start with point #2 -- as in don't wait for tomorrow, and come back to point one in examples 3 & 4. Consider this 401k plan, these economic assumptions, and a fictional employee "Joe" for all of the examples in this epinion:
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Age 22 Compensation: $ 25,000
Annual Salary Increase: 5%
Average Return on Investment: 8%
Company Match: 2/3rds of the first 6% pretax contribution
(ie 4% maximum)
IRS Deferrals Limits: Assume they do not apply
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Example I: Joe starts contributing 6% of his income (pretax) at age 22
Joe is a smart guy and by placing 6% of his income (10% after the company match) annually in his 401k account: He will have approximately the following available at these possible retirement ages from his 401k:
Age 55: $ 730,000
Age 60: $1,160,000
Age 65: $1,820,000
Example II: Joe starts contributing 6% of his income (pretax), but not until age 32
Joe is having too much fun to worry about retirement at age 22, at age 32, he realizes he's halfway to 65. No harm done right? Wrong! Joe now has the following available at the same possible retirement ages:
Age 55: $ 440,000 =====> 60% of what he would have had
Age 60: $ 730,000 =====> 63% of what he could have had
Age 65: $1,200,000 =====> 66% of what he could have had
No problem, Joe can just invest a little more to make up for his indiscretion right? No again! To make up, due to interest compounding and the leveraging due to the company match, Joe would have to invest this additional amount (in addition to the 6% to get his full company match) in his 401k for each potential retirement age:
Age 55: 6.7% (12.7% total)
Age 60: 5.9% (11.9% total)
Age 65: 5.3% (11.3% total)
Example III: Joe blows off his 401k and invests himself in money market funds beginning at age 22
Joe doesn't want to deal with possible hassles for withdrawing his 401k, so he invests in a savings account. (Assume for the sake of simplicity that the annual tax costs and taxes made on investment gains directly offset the withdrawal tax liabilities at retirement -or- that he is investing in an IRA type account) Joe's available funds at retirement are as follows:
Age 55: $ 440,000 =====> 60% of what he would have had
Age 60: $ 700,000 =====> 60% of what he could have had
Age 65: $1,090,000 =====> 60% of what he could have had
Note: This is as you would expect because he gave up 40% of his annual investment (the match)
Example IV: Joe puts 4% in his 401k and 2% in savings at age 22(again assume taxes "offset").
Joe now has 86.7% of what he would have had or:
Age 55: $ 635,000
Age 60: $1,000,000
Age 65: $1,580,000
Conclusion
If you start planning your retirement early and use the financial vehicles (such as 401ks) at your disposal, you can painlessly build up a nice nest egg.
If you are over cautious about penalties, and give up even a small portion of your company match, you unnecessarily limit your retirement savings much more than any possible 10% penalty (only if you need a hardship withdrawal). Having additional savings outside of your 401k is smart, but not at the expense of giving up some of your company match.
If you wait to start saving, it is very hard to catch up; that said, don't worry about the past -- start now! There is no magical start age, the point is, the longer you wait, the more you must sacrifice from your current consumption.
Note: If your company's 401k does not offer a company match, if your company does not offer a 401k, or if you are self employed, that changes the picture quite a bit. There are other options open to you, but much of the above would not apply as written.
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DoubleCoog
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