Today’s Opportunity Lost Or Retirement Opportunity Cost In Your Paycheck

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Are you struggling with giving up part of your paycheck today in order to fund your retirement? Often, we obscure retirement terms like tax-deferred, percentages, matching contributions, etc. let’s add some hypothetical examples to help clarify. I used RetireReady Solutions’ Paycheck Calculator and related Retirement Projections. They provide software for financial professionals to work with their clients on retirement and financial wellness.

Let’s say that you are a single, 30-year-old, living in the state of Illinois. You get paid every two weeks. You plan to retire at your Social Security Full Retirement Age of 67. The following table shows the amount of money you would save at savings rates of 3%, 6% and 9% in tax deferred accounts.

Dollar savings per paycheck from various savings rates

Annual income Bi-weekly paychecks 3% savings 6% savings 9% savings
$52,000 $2,000 $60 $120 $180
$104,000  $4,000  $120  $240  $360
$156,000  $6,000  $180 $360  $540
$208,000 $8,000  $240  $480  $720

For example, if you make $4000 per paycheck, these increasing percentages equate to $120, $240 and $360 per paycheck. Too often the conversation is around percentages and not on the dollar amounts that are being saved. Further, the conversation often turns to getting the free money from your employer rather than what is the effect on your future retirement which will quickly address.

Note that the maximum for a 401(k) for a 30-year-old stands at $6000, so you may not be able to save the amounts below unless you are in a 401(k) which has a limit of $19,000 in 2019 for 30-year-old. If you have a 401(k) that provides a 100% match up to 3% of income, often called Safe Harbor, then simply by saving 3% and getting the match you would get 6% without sacrificing 3% more of your cash. Some have told me that they thought the 3% match was what limited their savings. Not true. You can save up to $19,000 in 2019. With that knowledge, what if you saved 6% and got a 3% match for a total of 9%? You’ll see why you may want to do that in the last table.

Your savings is being done on a tax-deferred basis. That means, that you don’t pay taxes on that money currently. You will in the future. It also means that any money that you make, gains, won’t be taxed either. Taxes on income that come from wages and Social Security, are taxed differently than income made on long term gains. Short-term gains are essentially treated like income currently and will also be in the future, no matter if the gains from your investing would have been categorized as long term. The table below shows what that looks like for each income.

Marginal income tax rates*

tax rate
Long term
Capital Gains
 $52,000  22%   15%
 $104,000   24%  15%
 $156,000   24%  15%
 $208,000   32%  15%

Tax deferral means that you will not actually see the dollar amount reduction that equates to the savings rate from our first table. For example, if you make $4000 per paycheck and save 3%, you will only see your paycheck reduced $85.26 on your $120 per paycheck savings. In that case you can see the opportunity lost to spend today, from a tax basis equates to $85.26. If you decide to save $240 (6%), you’ll see a reduction of $170.52.

Change in take home pay for various 401(k)/403(b) savings rates

Bi-weekly paychecks Net tax Fed, IL St Net tax +3% savings  Diff Net tax +6% savings  Diff
$2,000 $1,499.44 $1,455.61 $-43.83 $1,411.78  $-87.66
 $4,000 $2,795.13 $2,709.87  $(85.26) $2,624.61  $(170.52)
 $6,000 $4,063.13 $3,935.24  $(127.89) $3,807.35 $(255.78)
$8,000 $5,197.25 $5,046.05  $(151.32) $4,894.73  $(302.52)

Most importantly, what does this mean for your retirement?

Projected 401(k)/403(b) savings at retirement from 3, 6 and 9% savings rates

Annual income Bi-weekly paychecks 3% savings 6% savings 9% savings
$52,000 $2,000 $311,355 $632,052 $943,404
$104,000  $4,000 $622,709 $1,264,097 $1,886,805
$156,000  $6,000 $934,063  $1,896,149 $2,830,210
$208,000 $8,000 $1,245,416  $2,528,197 $3,773,613

A $104,000 earner, saving 3%, would have $622,709; saving 6%, $1.2 million and saving 9%, $1.9 million. These results assume an accumulation rate of return of 6%, compounded annually and no annual raises.The more shocking example is the $208,000 earner. It’s easy to see a significant lifestyle difference when you saved $1.2 million, $2.5 million or near $4 million. That appears to be a substantial impact on the retirement lifestyle that high income earner would be able to live. That said, I know people who struggle to save any money today because of their desire for a current, higher standard of living .

Tax deferral means that you will pay taxes in the future. While these accumulations look great, they don’t account for taxes. That means that every time you pull out money, you will receive a net of the amount withdrawn not the gross amount. I have seen many people be disappointed to find that pulling money from their 401(k) account is not the same as pulling money out of their checking account.

During tax season many people focus on getting a refund. In 2017, the IRS reported an average refund of $2763. That’s near the 3% savings rate for a $104,00 income earner.  It’s reported that about half of the people in employer-sponsored plans don’t contribute. In this case if there was a matching contribution that refund doubles to $5600. The accumulation on 6% savings is $622,000 more than the alternative. Hopefully this highlights the opportunity cost of not saving early and often. When you’re 67 or whenever you decide to retire, will the coffees, drinks, electronics, dinners that you had in the past make up for the money you do not have? How will this lack of money impair your retirement lifestyle when you no longer have 8 to 10 hours of work filling up your time?

Hopefully this article helps you reassess your savings. What is it that you want to do when you retire? How much will it cost? How long might you live? Equipped with that information, what accumulation amount will you need to pay for it? Hopefully, it will be as simple as looking at the accumulation table to tell you how much you need to save. Then you’ll know why you are sacrificing spending today for the tomorrow you envision.

The information contained in this material has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. None of the information in this document should be considered tax or legal advice. Therefore, you should consult your tax or legal advisor for information concerning your individual situation before investing.

*Tax rates were pulled from the College for Financial Planning’s 2019 Annual Limits.

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