401(K): Costs of Waiting

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Anyone can find an excuse to put off pushing money aside for retirement: It’s too complex and I’m busy, I need money now since I just got out of school, I’ll do it later …

But the problems with delaying setting up your 401(k) are magnified even more if you are passing up the option to get an employer match. If you get a 5% match then the first 5% of your income that you set aside for your 401(k) essentially automatically receives a 100% return on investment. No investment option will ever offer an immediate and guaranteed return like the matching money offer by your employer.

The main issue facing young professionals is they are heavily indebted from school and thus can’t pay down loans like they want to and still save for retirement. The rates on your student loans are probably less than 7%, and your credit card is at most 20%. If this is your excuse for not contributing to your 401(k) and you miss matching money then your gap is still an 80% return between interest building up on your credit card and the missed investment opportunity in your 401(k). Continue to pay down debt; just don’t miss this opportunity … so pay your debt down slower in this case.

If things are just “tight” and you aren’t able to save 5% of your income, then the hard truth is you are simply living beyond your means. Even if you aren’t offered a 401(k) match by your employer you should still set aside 5% of your income into an IRA or Roth IRA with the goal of building your overall retirement savings rates towards 15% of your income. If you are unable to meet these savings targets then set a goal to adjust your lifestyle since your current spending levels are simply not sustainable, and you are not setting yourself up to build wealth.

To hit this point home I want to give an example of someone who begins contributing to their 401(k) at 25 compared to someone who starts at 30.

Let’s start with a few assumptions:

  • You will retire when you are 60.
  • Current income at age 25 is $50,000.
  • You contribute 10% and receive a 5% match from your employer.
  • Your income grows annually at 4% (this is going to vary greatly among us).
  • The compounded annual return on your 100% allocation to equity investments is 10% (large U.S. stocks have returned 10.17% as a compound annual return according to the Ibbotson 2020 Yearbook).

In this scenario, the champion who got focused and set up their Traditional 401(k) at age 25 will have almost $700,000 more in their retirement account than the slacker who waited five years to get contributions rolling. Here is this scenario presented graphically (Remember, this assumes a steady compounded investment return rate. Your investment returns will be volatile but over the long-run, if these averages hold then your ending balances should approach those represented below):

401k funding projections

  • The ending balance in a traditional 401(k) based on the above assumptions is about $2.7 million for an investor starting contributions at age 25 compared to about $2.0 million for an investor starting contributions at age 30.
  • This massive difference is even larger when we account for those who also began additional savings outside of their 401(k) at age 25 compared to 30.

These numbers are not inflation adjusted – meaning that these balances will be worth relatively less in 40 years compared to now since prices for all goods will be higher due to inflation. However, the difference in your account balance seen through investing early is still sizable and will result in a much more favorable retirement for those who got started early.


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