Recently I’ve been thinking a lot about 1 issue that’s quite tricky, and really have not found much in the way of advice on, so I’m putting my thoughts to you readers. You always seem to have valid points and good advice.
So, recently I had a slight problem with my cash flow, and decided to lower my 401k contribution from 8% of my salary to 4%, which is what my company matches full to. The reason I did this was so that I could free up more cash to use for debt repayment and get out of debt faster. I began to think about it though, and started to wonder if I was handicapping myself in the future, so I decided to look into it.
At my age, I’m allowed to have a fairly risky portfolio, as I am a long way from retirement, so I could be losing out on stocks at cheaper prices by lowering my contribution now, and increasing it later when I’ve got more room to spare to save for retirement. Here are the things that I think I’m missing out on by dropping my contribution:
- Low stock prices that will gain in the future
- Compound interest on higher returns due to lower capital input
Here are some of the things i’ll gain from my decision:
- Debt freedom earlier than before, assuming same salary
- improved cash flow
So, how much am I going to lose in the future because of this decision? Well, the numbers on this are difficult to run, but lets give it a try anyway. First, I need to decide how much money I’ll need in retirement. These numbers are slightly difficult, as my life situation will change as I get older, have kids, etc. This could be outdated in 3-5 years, but for now, it’s accurate to the best of my knowledge, so Its getting used. I used a retirement calculator at cnnmoney, which you can find here.
The calculator estimates 25% federal tax, and 0% state tax (conservative state governments rule), although both of these factors could change between now and when I retire in 2050, and I wouldn’t be surprised if they did at all.
It also counted on me receiving approximately $10,000 per year from social security. This year, social security is expected to pay out more in benefits than it takes in, a point it was not expected to reach until 2016. This was partly caused by massive layoffs during the recession, and partly by other factors. Given the current political climate, the US debt levels and general mood, I’m not expecting anything from this program, and essentially treating it as a black hole for my dollars. If I see *any* money from this at any point in my life, I’ll be surprised.
Beyond that, it said I’d need ~300k in retirement (I think this is way low) but that at the rate I was going, I’d have a 97% chance of reaching my goal. The same choices I put in for a 4% contribution were used for an 8% contribution, and it assumed I would need lower returns and had a 99.96% chance of making it. Unfortunately, This didnt provide me with the dollar amounts I was seeking, So I went to find another one.
The retirement calculator at retirementcalculators.org showed what I was looking for: A final estimated account balance based on a rate of return. So, the question is, How much am I costing myself by lowering my contribution?
With a 4% contribution over 40 years earning 7 % interest, my final balance would be $420, 574. However, if I used the 8% amount for contributions, my total is $816,489! Wow, that’s a huge difference, but it’s assuming some things.
- That these rates of contribution stay the same throughout the 40 years, which I dont expect to be the case.
- Return rates hold steady near the average of 7%
Now, have I really just robbed myself of almost 400k of “future income” (if you’re wondering why i’m calling it that, check this post on pop economics)?
I dont really think so, and here’s why:
- Funding my retirement is something that I’d like to do, but I have other goals that I would rather complete now. So if I put this on “autopilot” I’ll still have a tidy sum (and probably more than most) when I’m ready to retire
- I’ll be honest with myself, I don’t really see my self retiring full time. As it stands now, I’d probably get bored of doing stuff, and even if it’s just a hourly wage or a volunteer gig, I’ll need to be out and about
This was meant to be a bit of a primer into the give and take of paying off debt vs funding 401k at an early age. Not an exhaustive guide, and definitely not for everyone. Tailor this to Your goals and Your desires, not to mine.
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No, you didn’t rob for yourself. I’ve been in the market for the past 13 years and I’m still waiting for this rate of return that we’ve been promised. As long as you’re making steady contributions and you’re not losing money every year, you’ll be fine I guess.
Sandy,
You’re probably right. I’m at least getting a 100% match on some of the money that I contribute, so at least not all is lost. Hopefully at some point in my life those 7% returns the stock market always gets are going to materialize.
Jeff
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