Let me ask you a question. Are you going to retire someday or not? If you answer in the negative, stop reading this article, and go enjoy some ice fishing. If you say yes, why are you behaving as if that day will never come?
When I was in college, I spent an entire 24-hours, at an all-night diner, learning a semester’s worth of history. I passed the class, but not with stellar marks. Procrastination caught up with me, but I was able to soften the blow of neglect, by devoting myself to an intense period of “cramming.”
That is what most retirees-in-waiting think they will be able to do with their savings. They will enjoy life during their young years of employment, and then get real serious as the day of labor-departing draws closer. Wrong!
It’s not that you won’t have the will, or even the money to do it. It’s that the IRS doesn’t let you save for retirement that way. In 2015, you, as a taxpayer, were allowed to contribute up to $18,000 to your company-sponsored 401(k) plan. How long would $18,000 last in retirement? Worse, that amount will be staying the same for 2016. This contribution ceiling applies to other tax-deferred retirement vehicles like 403(b) accounts, 457 accounts or the federal Thrift Savings Plan (TSP). All will remain capped at $18,000. In addition, the contribution limit for IRAs, will continue to be $5,500 for 2016.
Half of all People on Medicare had Incomes
[Equivalent] to 200 Percent of Poverty
Let’s do some math. If you are five years from retirement, and you are ready to get serious about the future retired you, how much could you pack in with these contribution restrictions? (18,000 x 5) + (5,500 X 5) = 117,500. Good luck entering what could be the longest phase of your adult life with $117,500 stashed in an account somewhere.
Of course you could just put your money into a taxable account, and save that way, but you would lose the third tier of compounding. Remember, simple interest, is a gain on your principal only. Compound interest is gain on your principal and interest. The third level of compounding comes when you gain interest on the money that you would otherwise have to pay in taxes. Only savings in a tax-sheltered account draws triple compounding.
Let me whisk you away, and show you the coming plight of your Christmas Future. We are standing at the foot of a grave, but it’s not what you think. It isn’t you in the ground, it’s the remains of your insufficient savings. One in five seniors spend their retirement years in poverty. They didn’t start out that way. Most of them made a decent income during their employment. But they failed to put back sufficient funds for their post-labor decades. (Yes I said decades). A couple can expect one of them to live well into their 90s. As a result, their savings, if insufficient, can run out. In 2013, half of all people on Medicare had incomes less than $23,500, which is equivalent to 200 percent of poverty in 2015 according to the U.S. Census Bureau. One-third of seniors would be absolutely desolate were it not for social security income. Not a pretty picture. If you aren’t saving diligently for this coming event, your chances of being added to these statistics increases with each passing year.
Of course, none of this is going to happen to you, right? So, in spite of seeing the tombstone of your retirement, you ignore the premonition and continue the status quo of not saving. Time goes by, retirement comes, and before you can….., your are twenty years deep into your “golden” years. There’s no money left. You’ve borrowed all you can from relatives and friends. After living a lifetime in relative comfort and ease, you find yourself having to adjust to a life of impoverishment.
But good fortune shines down on you. While you are at the dump looking for discarded aluminum cans, so you can eat that day, you stumble across a time machine. It can only be used one time, and you can only stay in history for one minute. What to do. After some thought, you decide to go back to a time when you were young. In a flash, you are standing in front of a startled younger you. You grab the lad by the collar, slap him a couple of times for causing you so much suffering, and instruct your young upstart self to contribute the maximum into your historical employer’s 401(k) or else. The stench from your unwashed clothes and the deep grooves etched in your contorted face, convince the novice you’re telling the truth. When your minute is up, you get back in the time machine and go back to your time. You go to the bank to see if your trip was effective. After a respectable 8 percent return on your money, (through triple compounding), you discover that you are now the proud owner of $1,269,282.11! “Nice job younger self,” you say as you drive home in your BMW.
Are you still young enough to contribute to your retirement for another 20+ years? If so, you don’t need a time machine. Your time is now. Either save or suffer the consequences for the rest of your life. Tennessee Ernie Ford said, “You can be young without money, but you can’t be old without it.”
If you continue to ignore the clock, and spend your money on new phones, tablets, vacations, etc., and not on your own future, I advise you to stop throwing away your soda cans. You’re going to need them.
Glossary of Terms
A retirement vehicle where employees of a (for-profit) company can elect to have a portion of their income withheld, and placed in a savings account. The money withheld is “pre-taxed” and does not show up in the taxable box of their W-2. While in the 401(k), the gains earned grow tax-deferred. Only when funds are removed are they subjected to income tax.
Generally, the contribution limits (ceiling) are higher in an employee-sponsored 401(k), than a personal IRA. Some employers offer matching funds as a way to encourage saving.
Tax deferred refers to the way a savings account is taxed. As long as investments stay in the tax shelter via employer-sponsored plans, IRAs and annuities, any gains will not be taxed. However, the word “deferred” means that taxes will be due some day on the accumulation. This should not be confused with “Tax Free” shelters such as a Roth, where the gains will never be taxed.
The 403(B) works identical to other tax-deferred shelters such as 401(k)s, and IRAs. The difference is who may contribute. These shelters are used for non-profit organizations such as school teachers and church employees.
Thrift Savings Plan (TSP) is tax-deferred shelter much like a 401(k), but used by federal government employees, and members of the uniformed services.
A taxable account is any account where gains (interest or capital gains) are subject to annual tax reporting. General savings accounts and any other non-sheltered accounts must report any gain annually, usually on various 1099 forms, and must be reported on the owner’s 1040 tax return. Such accounts disallow the “third tier” of compounding, forfeiting any interest that would have been earned on the taxes that were paid that year. Had the money been in a tax-deferred account, no taxes would have been due at the end of the year, leaving more money in the account to grow.
Interest gained on the original contribution only. Example: A person purchases a bond for $5,000 that pays an annual return of 5%. In the first year, the owner of the bond receives a check for $250 (5,000 X 5% = 250). In the second year, the same amount is paid. Each year the owner receives a check for $250 until the bond matures. Instruments such as bank CDs and bonds pay simple interest.
Unlike simple interest, compound interest pays twice. First, interest is paid on the principle (the original investment amount), then again on any previous interest paid. Example: A person deposits $5,000 into an investment account that pays 5%. In the first year, the account gains $250. In the second year, the value of the account is $5,250 due to the previous year’s interest payment. The interest payment for year two is $262.50. How did the amount grow? Compound interest. (5,250 X 5% = 262.50).
5,000 at 5% for 10 years.
Simple Value: $7,500
Compound Value: $8,144
Social Security Income
This is a monthly income sent to individuals who reach retirement age (62 or later, depending on when you were born). When you work and pay Social Security taxes, you earn “credits” toward Social Security benefits. The number of credits you need to get retirement benefits depends on when you were born. If you were born in 1929 or later, you need 40 credits (10 years of work). If you stop working before you have enough credits to qualify for benefits, the credits will remain on your Social Security record. If you return to work later, you can add more credits to qualify. The government won’t pay any retirement benefits until the required number of credits have been earned.