Financial essentials
Small changes can lead to big benefits in the future.
Even a 2% increase in retirement savings can lead to a more secure future.
Save now for a better tomorrow.
When you think of your future, you’re likely imagining things you want to experience. With more free time in retirement, many people hope to be able to kick back and enjoy what they love.
But that hope may depend on how much you have saved. Even if you’re saving part of your paycheck in a 401(k) or 403(b) workplace plan, increasing your contributions may help you enjoy life in retirement even more.
Let’s look at a hypothetical employee and explore how increasing contributions can have a positive impact on your retirement.
See the power of increasing contributions in action.
Meet Jessica. Here’s what her salary and 403(b) account look like.
Salary: $50,000
403(b) balance: $3,000
Contribution: 3%
Company match: 5%
Average annual growth rate: 6%
Jessica is 25 and manages programming at a nonprofit focused on mentoring youth. She likes it, but what she loves most is heading to the beach, practicing yoga and kicking back in the sand with a mystery novel. She hopes to retire at 65 and do a lot more of all three.
Each year, she is personally contributing $1,500, or 3% of her salary and getting a matching contribution from her employer though not as much as she could get.
This means each year $3,000, or $250 each month, is being contributed to her 403(b). The performance of her 403(b) account will change with the market, and her personal performance has to do with the investment choices she makes within her account. For this example, we’ll say the average annual growth rate of her account is 6%. The growth increases her balance (in addition to her contributions and her employer’s match) meaning her account may grown even more in the future. This is known as compounding growth.
Jessica's current 403(b) trajectory
With the average annual growth rate of 6%, her account could grow to $523,908 by the time she retires in 40 years,1 if all factors stay the same2 in terms of salary and contributions.
Other factors affect your annual income in retirement like Social Security or other retirement assets like
See the impact of contributing 5%.
So what if Jessica increases her contributions to 5%? Since she earns $50,000 annually, increasing contributions by 2% may seem like she’d have $1,000 less. While her paycheck would now be smaller, it would be only $65 less because of tax savings.3 If she is comfortable with this reduced amount, she should definitely consider increasing her contribution rate.
But that’s only half the story. Because increasing her contributions would mean she would now get her full employer match. That’s $1,000 more in free money each year that her employer is now providing for her retirement plan that she had been missing out on.
The power of increasing contributions
That would mean the total 403(b) contributions to her account would reach $416.67 each month. Over 40 years, her contributions, her employer’s match, account earnings, and compounding growth could net out to $850,213 by retirement,4 if the average annual growth rate continued at 6%.
What could this mean for her lifestyle? Maybe short overnight trips to the shore could become long weekend getaways with more time to kick back and read all the books she’d like.
See the impact of contributing 10%.
Now if she contributed 10% of her salary, her account contributions would total $625 each month when including her company match.
This means she could have significantly more retirement savings than if she stuck with her current 3% contribution rate. And this could mean a much brighter future she could even consider some beach trips or yoga retreats abroad, or look at a few weeks at a beach timeshare.
So what is it you hope to do with your retirement savings? And
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When to keep contributions the same.
Ideally, you don’t want to withdraw from a 401(k) or 403(b) early (before 59½) since this triggers a 10% IRS penalty. So, there are times when it may not be best to increase contributions. It may be wise to keep your contributions the same if you:
- Plan to purchase a home
- Need to repair or purchase a car
- Have a planned large expense coming up
- Do not yet have emergency fund savings
Once you’ve paid off the expense, or have a plan in place to do so such as a mortgage or auto loan, you can then reevaluate your finances. You’ll want to consider the terms of any ongoing payments to see if it is in your best financial interest to increase 401(k) or 403(b) contributions. Talking with a
Another time to keep your contributions the same is when increasing them could make you cash poor. This happens when you don’t have enough money to cover everyday living expenses because much of your wealth is in assets that can’t easily be converted to cash, like a house or a 401(k).
That said, if you can increase your contributions, the more time your funds will have for compounding.
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1 U.S. Securities and Exchange Commission,
2 Assuming quarterly compounding and that this hypothetical individual does not get a raise, bonus, different job or withdraw money from their account.
3 At 3% contributions, this hypothetical individual would pay $10,340 in taxes on $47,000 of taxable income. Assuming monthly paychecks and total tax rate of 22%, this hypothetical individual would earn $36,660 or $3,055 per month. At 5% contributions, this hypothetical individual would pay $10,120 in taxes on $46,000 of taxable income and then earn $35,880 or $2,990 per month, for a decrease of $65 per paycheck.
4 U.S. Securities and Exchange Commission,
This material is for informational or educational purposes only and is not fiduciary investment advice, or a securities, investment strategy, or insurance product recommendation. This material does not consider an individual’s own objectives or circumstances which should be the basis of any investment decision.
The above illustration is intended to show a hypothetical example of the principle of compounding. The example does not include the impact of any investment fees, expenses or taxes that would be associated with an actual investment. If such costs had been taken into account, the results shown would have been different. It also does not factor in market volatility.