We can debate the finer mechanics of personal finance for what would seem like eternity. Questions like asset allocation (AA), stocks vs. bonds, 401(k) vs. Roth 401(k), etc. will live on for years. The question of savings rate, however, is about as cut and dry as America having an uptick in small digit amputations on Independence Day.
What a High Savings Rate Does
Let’s take a simple scenario into account. A young professional graduates from a middle-of-the road state school with a degree in Accounting. Average GPA, medium cost of living area, normal expenses. If this young professional starts with a salary of $50k annually, they have the opportunity to amass wealth at a feverish pace. On day one, they should attempt to hit the maximum IRS contribution for a 401(k) for 2020 which would be $19.5k. If they do this, starting at their current age of 22, and continue until age 57, they would have accumulated $1.86MM assuming an annual return rate of 5%. That’s right, this simple step could put them on pace for a very happy retirement.
What about matching contributions you ask? Well, I’m glad you said something. Let’s say their employer matches up to 5% of their salary, which isn’t uncommon. This would equate another $240k over their lifetime, now bringing their total 401(k) balance over $2MM at age 57. You probably think we’re done, right? Nope… there is more!
Let’s say you’ve been with your company five years now and have earned $15k in annual raises and now make $65k a year. After a few years of avoiding new car payments, designer clothes, and that new 93 inch ultra high frequency laser LED nanotechnology TV, you’re able to put this new raise into a Roth IRA at the rate of $6k annually (IRS max). This money, which is funded with post-tax funds and then withdrawn in retirement tax free, will accrue to approximately $400k at age 57. Your retirement funds now total >$2MM in tax deferred accounts and $400k in Roth accounts at retirement. $2.4 MILLION!!! We’ll stop the calculation at this point. But remember, it wouldn’t be unusual for an accountant to become a CPA and earn upwards of $100k for the majority of their career. This, along with maintaining good financial habits, could exponentially increase the final portfolio potential. Not to mention the added benefit of lowering your tax liability, which you can read about in some of our follow-on articles. (NOTE: these calculations do not include future increases in IRS contribution limits to retirement accounts or the catch up provisions for individuals nearing retirement. These could both increase the end savings sum.)
But What if I Get Married?
I’m glad you asked. If you end up getting married, your spouse will now have $6k in Roth IRA space based on your income. If your spouse works, they’ll likely have $6k in Roth IRA space and some other 401(k)-type account. If this is true, you can basically double all of the numbers above. Just think, as a married couple in their late 50s, you could be retiring with upward of $5MM. This can be done by simply maximizing the tax-advantaged space available to nearly all American workers.
It’s Simple, But It’s Not Easy
I’m not going to sit here and keyboard warrior my way to telling you this is easy. It is not easy. In fact, it takes a good amount of discipline. It takes the discipline to commit to good habits and continue them over a 30+ year career. The benefit of starting early is that you can train your brain to forget about the money going toward your retirement accounts. Heck, I certainly wish I could time travel back to my 18 year old infantry Marine self and share this article. That $1452/month starting salary could have gone a little bit further if I did.
The Other Benefits
So there is a hidden benefit to maxing out retirement accounts at a young age, and that is the absence of guilt when you do spend money. If you are already meeting or exceeding all of your savings goals, and have been for some time, why should you feel guilty about the new 75” TV you just bought, or your weekly cup of brew from your favorite coffee shop, or that ad-free version of Hulu you splurge on. Whatever your thing is, it’s much easier to justify when you are crushing your savings goals. Sleeping at night gets a lot easier.
Remember – you have 30-40 years of savings ahead of you! Why not tilt the odds in your favor by starting young?