Your paycheck can only stretch so far, so you should feel very good about your decision to have some money taken right off the top and put into your retirement savings account. When retirement rolls around, you’ll be glad that you kept contributing over the years. Here’s how to feel at ease for contributing to savings.
It may sound easy, but in reality, saving for retirement isn’t always easy. Things come up that make it tough to keep saving. What happens if you need to replace a car? Or you’d like to buy a house and start a family? Or one of your kids is starting college? There are any number of reasons why you might be tempted to stop contributing to your plan so you can free up some cash. Just for a few years, you may say; after all, how much difference could it make?
The answer may surprise you. Taking even a short break from saving could significantly affect the amount of savings you’ll have when it comes time to retire.
Taking a Break Takes a Toll
Taking a break from saving for retirement could put your future financial security during retirement at risk. Take a look at the toll a five-year and a 15-year break could take.
|Annual Conribution||No Break||5-Year Break||15-Year Break|
|Years 6 – 10||$2,000||0||0|
|Years 11 – 20||$2,000||$2,000||0|
|Years 21 – 40||$2,000||$2,000||$2,000|
|Account value after 40 years||$331,915||$261,883||$171,470|
You’ve Got a Good Thing Going
No matter how disciplined you are, a short break can very easily turn into a longer one. And even though it might seem like it’ll be easy to start saving again in a few years, there’s no way of knowing what will happen. It’s very possible you’ll be facing some pressing financial demands then, too. The thing is, you’re already in the habit of contributing to your plan.
And Uncle Sam Is Helping
If you take a break from contributing, you are also taking a break from some important tax benefits.. The contributions you make to a workplace retirement plan (WRP) or IRA may be tax deferred**. Tax deferred means you don’t have to pay federal income tax on the money you contribute until later, when you withdraw it. Earnings on your WRP or IRA are also tax deferred until you withdraw them. These tax breaks can help your balance grow.
A Smart Way To Save
Take a look at the difference between making pre-tax contributions to a tax-deferred account and putting after-tax money in a taxable account.*
|Tax-Deferred Savings||Taxable Savings|
|Pretax income available for saving||$5,200||$5,200|
|Federal income taxes (25%)||-0||-$1,300|
|Annual amount saved||$5,200||$3,900|
|Average annual return (6%-25%)||6%||4.5%|
|Number of years saved||30||30|
|Amount saved after 30 years||$435,290||$246,800|
|Federal taxes payable upon distribution (25%)||-$108,822||-0|
|Total accumulated for retirement||$326,468||$246,800|
The Best Choice
Choosing between having more cash now and having more savings when you retire isn’t easy. But the long-term costs of taking a break could be steep. You might have to postpone retirement, retire and keep working part time, or scale back your retirement dreams. Whenever possible, make saving for retirement a financial priority. You stand a much better chance of accumulating enough money to afford a comfortable future if you keep on saving.
*This is a hypothetical example used for illustrative purposes. It does not represent the results of any particular investment vehicle. A 6% annual return (compounded monthly) is assumed. Your investment results will be different. Tax-deferred amounts accumulated in the plan are taxable upon withdrawal.
**WRPs with a Roth contribution option as well as Roth IRAs are retirement options that do not offer immediate tax savings for Roth contributions. However, qualified Roth distributions from either retirement account are not subject to federal income taxes when all requirements are met.