Delay In Saving Raises Payments Later On

By Denise Appleby

While it is never too late to start saving for retirement, putting it off for too long can take a big bite out of your retirement nest egg. In Making Salary Deferral Contributions Part 1 and Part 2, we discuss some of the benefits of making salary deferral contributions to an employer-sponsored retirement plan. In this article, we discuss the compounding effects of these benefits if you start saving early.

Starting Early Makes It Easier to Reach Your Goal
Studies show that most individuals will need a retirement income equivalent to between 60% and 90% of their pre-retirement income in order to maintain their current standard of living during their years of retirement. To achieve this, many individuals must start to save at the earliest opportunity. By starting sooner rather than delaying your savings for a few more years, you can reduce the amount you must save every month to reach your retirement goal.

Example 1
Tom and Dick, both age 21, start their first job where they receive the same salary. They share the same apartment and split their household expenses equally. During the first week at work, they attend a seminar where they learn about the benefits of participating in their employer's 401(k) plan.

Tom decides to start saving $100 from each month's salary. Dick, however, wants to wait until he is older before starting to save. If we assume an annual fixed rate of return of 6%, Tom accumulates approximately $16,700 after 10 years. Dick starts saving at age 31, and like Tom, decides to save $100 per month. By the age 65, Tom's retirement account would be about $253,000, while Dick's account balance, started 10 years later, would be about $132,000.

This is a hypothetical example only, and not a guarantee of future returns. Actual investment experience will vary with stock selection and changing market conditions.

Dick could try to accumulate $253,000 by age 65, but because he started 10 years later than Tom, he would have needed to save about $190, or nearly double Tom's, each month in order to reach that goal.

How Much Is Enough?
Your financial planner may be able to help you determine the amount you need to save in order to maintain your pre-retirement standard of living. Understandably, factors such as inflation and changes in income tax rates may alter the projected amount. However, having an idea of what you need for your future retirement makes it easier to determine if you are saving enough. The following example illustrates determining how much is enough.

Example 2
Sam meets with his financial planner who determines that Sam needs to accumulate at least $1,000,000 by the time he reaches his desired retirement age of 50. Sam's monthly-required savings is determined by his projected rate of return, the amount he has already saved and his current age.

Sam is age 25 and has a savings of $5,000. Assuming an annual fixed rate of return of 6 %, he will need to save an additional $1,400 each month to reach his desired goal. If Sam were 30-years-old, his required savings would be approximately $2,100 per month: a five-year delay increases Sam's required savings by $700 per month. (To see what you need to save each month to be comfortable during retirement, use this worksheet.)

If the limitations placed on the amount you save in your employer-sponsored plans and your IRAs are not sufficient to meet your goals, talk to your financial advisor about other savings vehicles that would better suit your financial profile.

On the other hand, if you are unable every month to save the amount required to reach your goal, you may still want to save whatever you can afford, as that will help defray your expenses during your retirement years.

Conclusion
Early financial planning helps to ensure a financially secure retirement. Explore all the options that are available and choose the ones that are right for you. Be sure to inform your financial planner of all your other expenses so that he or she can help you to make realistic plans. Remember, if you plan to start later, later may never arrive. The reasons for putting off saving for retirement may increase, such as a growing family, mortgage payments and college expenses. And if you are still not convinced that you need to start saving now, check out 10 Reasons to Put Off Saving for Retirement in the IRS retirement newsletter.