When children or grandchildren are starting a career, pressing interests—work, rent, food and the siren call of the smart phone—often take precedence over the remote, mundane prospect of funding retirement. Beginning a savings program early in a career, however, can pay considerable dividends down the road.
Hypothetical Retirement Savings Illustrations1
Let’s examine the hypothetical case of Jane, a 25-year-old earning $85,000 per year. Her employer offers a 50% match for each dollar she contributes to her company’s 401(k) plan, up to 6% of compensation. The following three scenarios reflect different saving schedules that Jane might pursue, and hypothetical outcomes given an assumed annual growth rate of 7.2% and annual salary increases that match an assumed inflation rate of 2.5%.
Illustration 1:Saving Early, Increasing OftenJane allocates 6% of her salary into the company 401(k) for the first five years, to benefit from the match offered by her employer. She increases her 401(k) allocation rate to 10% of her salary for the following five years, after which she increases the allocation to 15% until her retirement at age 65. Using a straight-line growth calculation (gross of fees), the hypothetical value of Jane’s 401(k) savings at the beginning of her retirement would be $3,600,000. |
Hypothetical Retirement Savings:$3,600,000Starting early and gradually increasing retirement plan contributions resulted in the highest hypothetical retirement savings. |
Illustration 2:Slow and SteadyJane allocates 6% of her salary into the company 401(k) for the first five years, then increases her 401(k) allocation to 10% and continues at that rate until her retirement at age 65. Using a straight-line growth calculation (gross of fees), the hypothetical value of Jane’s 401(k) savings at the beginning of her retirement would be $2,900,000. |
Hypothetical Retirement Savings:$2,900,000Even though Jane contributes less each year, by starting early, the hypothetical retirement savings are higher than in Illustration 3. |
Illustration 3:The Late BloomerJane postpones saving until age 35, then defers 15% of her salary into the 401(k) plan until her retirement at age 65. Using a straight-line growth calculation (gross of fees), the hypothetical value of Jane’s 401(k) savings at the beginning of her retirement would be $2,480,000. |
Hypothetical Retirement Savings:$2,480,000Postponing retirement plan contributions and foregoing the employer match for 10 years results in approximately $1.12 million less hypothetical retirement savings than Illustration 1. |
The good news in all these cases is that contributing regularly to retirement accounts has the potential to generate a sizable nest egg over time. Parents and grandparents may not be at the forefront of selfies or social media, but they have plenty to teach the next generation about saving and the power of compounding. Encouraging loved ones to invest in their future selves while they are still young can help smooth their path long after the allure of Instagram feeds has faded.