Whenever we talk to clients about their financial goals, the topic of having enough income after retirement is always part of the conversation. That said, how much money you contribute to your retirement plan now can make all the difference when that time comes.
When feasible, we often recommend that our clients max out their company retirement plan to take full advantage of contributions that are tax-deductible and tax-deferred. Putting away anything less than the maximum could result in giving up a significant tax break.
If you are not already maxing out, there are significant reasons for adding more to your retirement account. For one, the power of compounding will be on your side. Compound interest can often appear to work miracles with your money over time. Obviously, the more you have in principal, the faster the interest grows.
For example, consider an initial investment of $10,000. On a reasonable annual return of 8%, in 20 years that same $10,000 will be worth more than $46,000. Imagine if you were to continually add to this account, even incrementally, on a systematic basis how much your nest egg will grow. While rates of return are bound to fluctuate, the most important point is that the more you contribute today, the longer your money has to grow and the more you will have at retirement thanks to compounding.
Before you decide to max out your plan, you’ll need to know the current limits. The maximum you can contribute to a 401(k) or 403(b) is $18,000 in 2017. It’s $24,000 if you are over 50 thanks to the catch-up contribution limit of $6,000. In addition, SIMPLE IRAs and SIMPLE 401(k)s that may be offered have a maximum deferral of $12,500 in 2017 with a $3,000 catch-up contribution.
It may not be easy to just start contributing the maximum deferral amount immediately. If it isn’t possible right away, you can build up by making incremental increases until you reach the maximum. If you are like me and forget everything, taking advantage of the annual automatic percentage increase within your company retirement plan is something to consider. Enrolling in this option will automatically increase your deferral rate by a percent each year until you hit the maximum. Another great time to increase deferrals (if not already maxing out) is when you receive a raise. Getting a 3% raise and increasing your deferral by a percent still leaves you ahead.
But don’t forget, if your employer offers a match – this is essentially free money toward building your retirement nest egg – so anything you can do to get the maximum match will be another great benefit.
Back to the tax benefits of maxing out your retirement plan. Pre-tax contributions allow you to defer paying income tax on your savings when you are in your prime earning years – and most likely in a higher tax bracket. When you withdraw these funds in retirement, you will likely be receiving a lower amount of income and hence have the benefit of a lower tax rate.
If you are young, you will have decades before retirement and time appears to be on your side. However, it is in your best interest to contribute as much as you are able to now. Time passes quickly and you’ll be glad you did when the time comes for tapping into those funds.
If you are closer to retirement, you are hopefully in a good place with your retirement planning. Should you have any concerns about retiring or want to get a plan together, feel free to reach out and we will get you started.
Steve Kohler is Managing Director of DBR Advisory Services at D. B. Root & Company, a Pittsburgh-based wealth management firm. If you would like to contact Steve please e-mail him at email@example.com or call 412-227-2800. Read bio…
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