Spring is nearly here - and that means most of us will adjust our clocks ahead by an hour this Sunday, March 8th. It also means it's time for our annual reminder for those of you making contributions to an employer retirement plan to "spring forward" those deferrals as well. If this doens't apply to you, think about any friends or family who may be particpating in an employer retirement plan and share this article with them.
Periodically increasing your deferral rate is a good habit to develop that allows for further compounding of interest over time! With the uncertainty of Social Security in the future, you will find that more of the responsibility of providing yourself with a confident retirement income falls on you.
Working with employees has led us to the conclusion that they must consider increasing the amount they contribute to their company retirement plan over time in order to reach their desired retirement goals. Many employees start out contributing a small percentage of their salary early in their career - which is absolutely fine - but often forget to adjust their contribution upward as their career progresses and their salary increases. This can leave them with a shortfall at retirement. Making an annual commitment to increase your employer retirement plan deferral amount is a great habit to consider to avoid this situation.
When contemplating an increase in your payroll deferral amount, consider what might make more sense for you as an individual. For example, should you increase your pre-tax deferral or Roth deferral amounts from your paycheck? This is a question we get every day and our answer often is "maybe do a little of both...but also, it depends, as one size does not fit all!" Pre-tax deferrals from your paycheck mean you get a benefit up front as you do not pay federal or state tax on the deferred amount. This lowers your current annual taxable income. Your dollars stay tax-deferred and you pay tax on those dollars as you make withdrawals - normally in retirement. Another option is Roth deferrals, provided your employer plan allows them. There is no upfront tax benefit with Roth contributions, as you make them from your paycheck on an after-tax basis, paying the tax now on the entire contributed amount. However, after the contributions are in the employer retirement plan for 5 years, all the earnings become tax-free upon withdrawal in retirement!
The big question is, do you need the benefit of tax deferral to lower your tax bracket now - and, are you comfortable with paying taxes later as you make withdrawals in retirement? Or would you benefit by paying the tax now, allowing your employer plan nest egg to potentially become tax-free in the future? We can certainly help discuss both options with you, but you should also discuss which route to take - pre-tax or Roth - with a tax advisor as well. Remember, it is your money, your future, and your retirement!
Regardless of whether you defer on a pre-tax or Roth basis, you may be surprised by the impact that a slight annual increase in those deferrals can have on your savings amount at retirement. You might not miss a 1% decrease in your paycheck now, for example, BUT over time, your plan account balance will surely notice it! Your overall goal as an employee is to make it to retirement and enjoy your remaining years without fear of running out of money.
Take a look at how a 1% annual increase can help your savings goals!
Employee A earns an annual salary of $50,000, decides to defer 6% of their salary, and earns an estimated annual rate of return of 8% each year. Keep in mind that some years the rate of return might be more than 8% and, in some years, less. This is just a hypothetical illustration. After 10 years of deferring at the 6% rate, their estimated balance is $48,900.52.
Employee B also earns an annual salary of $50,000 and decides to start out with a deferral amount of 6% but decides to increase their deferral amount by 1% each year! Also earning estimated annual rate of return of 8% each year. After 10 years of deferring with 1% increases each year, their estimated balance is $82,400.65.
These examples are hypothetical only and do not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.
Compound interest is interest that applies not only to the initial principal of your account, but also to the contribution amount that you defer plus interest on the accumulated interest from previous periods!
Let's take it a step further! These illustrations do not include possible promotions with higher salary increases, employer matching contributions, or profit-sharing contributions from your employer - meaning the values could be even higher!
It is never too late to start planning for your future, so take a look at your cash flow and see if there is a way to add that extra 1% - or greater - increase into your employer retirement account each year! Our request for this weekend is to not only spring your clocks forward but also consider springing your retirement plan forward by increasing your deferral rate by 1%!
As always, please do not hesitate to reach out to us if you have any questions or would like to discuss your retirement goals!