Everyone knows that they should be saving
at least 10% of their gross income for retirement, but that can
seem like an impossible goal after paying all your bills. However,
don't just figure that goal is unachievable without first looking
at the after-tax cost.
For instance, assume you earn $50,000 annually
and your employer matches 50 cents for every dollar you contribute
to your 401(k) plan, up to 6% of your pay. If you put 6% of your
pay, or $3,000, in the plan, your employer will match 3%, or $1,500.
Your contribution really costs less than 6%, because the money
is taken out before income taxes. If you are in the 25% tax bracket,
your $3,000 contribution will save $750 in taxes, or 1.5% of your
pay. So, between your contributions and your employer's match,
you will contribute 9% of your pay toward retirement, but it will
only cost you 4.5% of your pay.
Made over long periods of time, those levels
of contributions can help significantly in funding your retirement.
If you contribute $4,500 annually starting at age 30, you could
potentially accumulate $837,460 by age 65 with an investment return
of 8% annually. (This example is provided for illustrative
purposes only and is not indicative of the return of a specific
investment.) If possible, you should strive to contribute
even larger sums of money. In 2010, the maximum 401(k) contribution
is $16,500, plus individuals over age 50 can make an additional
$5,500 catch-up contribution.
What if you don't have a 401(k) plan at
work? Take a look at individual retirement accounts (IRAs). While
you won't get an employer match, you can contribute to a deductible
IRA, if eligible, with pretax dollars, which reduces your contribution's
cost by your marginal income tax rate. In 2010, you can contribute
a maximum of $5,000 to an IRA, and individuals over age 50 can
make an additional $1,000 catch-up contribution. So, if you are
in the 25% tax bracket and make a $5,000 contribution, you'll
save $1,250 in income taxes. Or, you may prefer to contribute
to a Roth IRA. While you won't get a current income tax deduction
for your contribution, you can make qualified distributions free
from federal income taxes.
