So you finally graduated and landed a great entry position. Like many corporations, your company offers benefits such as health insurance, paid time off, and 401K. You are making a good starting salary. Trying to wrap your head around everything, you wonder how much you should invest in your 401K retirement account.
As far as you know, the Hunan Resource department automatically deducts 3 percent from your paycheck. However, you know your company matches up to 5 percent, dollar for dollar. You are thinking of investing more but are concerned that you have too many bills to pay. After all, you are still getting off on your feet and becoming independence. In addition, your student loan payments will begin soon. The dilemma is that you want to increase your saving but need the money to pay bills.
Let’s run some numbers:
To demonstrate an example, let’s say your starting salary is $38,000, and you can expect it to increase by 3% every year. You are 22 and plan to retire 40 years from now. From historical data, you can expect an average of 10% rate of annual return.
Assume that you contribute 3% and the company matches, dollar for dollar, up to 3%. In 40 years, you will have about $1.5 millions. Note that you have to pay tax on that amount and $1.5 million 40 years from now will not hold the same purchasing power as $1.5 million today. But for the shake of simplicity, you will have $1.5 million.
Now let’s say you muster up and invest 5%, ensuring that you get all the money that your company is contributing. Using the same assumption, you will have about $2.5 million, a difference of $1 million!
Sounds like a no brainer!
But, didn’t we agree that you need the money to pay your bills? That student loan payment will kick in before you know it.
Let’s calculate how much extra cash you would take home if you were to invest 3% rather than 5%. The difference is 2%, which comes out to be $760 a year. Though you have to pay tax on it. Assuming a 15% tax rate, of the $760, you will bring home $646, or about $25 every two weeks.
Yes, $25 extra.
In conclusion, make sure that you contribute at least up to the amount that your employer matches. Most HR Department usually takes 3% off of your paycheck. One phone to the HR Department and $25 dollars every paycheck will make you $1 million dollar richer when you retire.