Free Money for Your Retirement? You Betcha!
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
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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.
About the author:
Author & Seattle
accountant Stephen L. Nelson CPA has written more than 150
books. His bestselling book is Quicken for Dummies, which sold
more than 1,000,000 copies. His books have sold more than
4,000,000 copies in English and have been translated into more
than a dozen other languages.
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