It can be more than a little discouraging to start making retirement planning
calculations. You’ll usually find that to achieve the annual retirement income you
want, you need to be saving a lot more than is practical.
Suppose, for example, that you use a program like Quicken or Microsoft Money to
determine that your retirement savings should equal to $5,200 a year–which is the
same as $450 a month. (This savings amount will produce roughly $15,000 a year
of retirement income if you save for 20 years, increase your savings with inflation,
and earn 9 percent.)
Okay. That’s great information to have. But practically speaking, where do you find
this money? Well. first you want to get the free money that’s available.
The first source of free retirement money
While $450 a month seems like a lot of money, you may be able to come up with
this figure more readily than you might think. Say, for example, that you work for an
employer who’s generous enough to match your 401(k) contributions by 50 percent.
In other words, for every dollar you contribute, your employer contributes $.50.
In this case, you need to come up with $300 a month to have $450 a month added
to your retirement savings. To make this calculation, you divide the monthly savings
amount, $450, by 1 + the employer’s matching percentage, 50%. The formula
$450/(1+50%) equals $300.
The second source of free retirement money
Also suppose that you pay federal and state income taxes of 33 percent and that
you can deduct your 401(k) contributions from your income. In this case, the actual
monthly out-of-pocket amount you need to come up with equals $200, not $450.
To make this calculation, you multiply your share of the needed monthly savings,
$300 in this example, by 1minus the 33% marginal tax rate, which equals 67%
In this case, the actual amount you need to come up with on a monthly basis equals
$200 because $300 times 67% equals (roughly) $200.
Sometimes, most of your retirement savings money can come from others
Admittedly, $200 a month is still a lot of money. But it’s also a lot less than the
$450-per-month savings you need to add to your retirement savings. In fact, most
of the money in this example you need to save comes from other sources!
The preceding calculations argue for two tactics when saving for retirement. First, if
an employer offers to match your contributions to something like a 401(k) plan, it
will almost always make sense to accept the offer–unless your employer is trying to
force you to make an investment that is not appropriate for you.
TIP If you do want to contribute $300 a month to a 401(k) plan and need to reduce
your income taxes withheld by $100 a month to do so, talk to your employer’s
payroll department for instructions. You may need to file a new W-4 statement and
increase the number of personal exemptions claimed.
Second, any time you get a tax deduction for contributing money to your retirement
savings, it’s almost certainly too good a deal to pass up. As described in the
preceding example, you can use the income tax savings because of the deduction to
boost your savings so they provide for the desired level of retirement income.
Tags: 401 K Contributions, Dollar, Find Money, First Source, Free Money, Free Retirement, Inflation, Marginal Tax Rate, Match, Microsoft, Microsoft Money, Quicken, Retirement Calculations, Retirement Income, Retirement Money, Retirement Planning, Retirement Savings, State Income Taxes
